The New Keynesian Model and the Long-Run Vertical Phillips Curve: Does It Hold for Germany?

Jan Gottschalk and Ulrich Fritsche

No 521, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: New-Keynesian macroeconomic models typically assume that any long-run trade-off between inflation and unemployment is ruled out. While this appears to be a reasonable characterization of the US economy, it is less clear that the natural rate hypothesis necessarily holds in a European country like Germany where hysteretic effects may invalidate it. Inspired by the framework developed by Farmer (2000) and Beyer and Farmer (2002), we investigate the long-run relationships between the interest rate, unemployment and inflation in West Germany from the early 1960s up to 2004 using a multivariate co-integration analysis technique. The results point to a structural break in the late 1970s. In the later time period we find for West German data a strong negative correlation between the trend components of inflation and unemployment. We show that this finding contradicts the natural rate hypothesis, introduce a version of the New Keynesian model which allows for some hysteresis and compare the effectiveness of monetary policy in these two models. In general, a policy rule with an aggressive response to a rise in unemployment performs better in a model with hysteretic characteristics than in a model without.

Keywords: Cointegration; Vector error correction model; Unemployment; Phillips curve; Hysteresis (search for similar items in EconPapers)
JEL-codes: B22 C32 E24 (search for similar items in EconPapers)
Pages: 47 p.
Date: 2005
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Downloads: (external link)
https://www.diw.de/documents/publikationen/73/diw_01.c.43776.de/dp521.pdf (application/pdf)

Related works:
Working Paper: The New Keynesian Model and the Long-run Vertical Phillips Curve: Does it hold for Germany? (2006)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:diw:diwwpp:dp521

Access Statistics for this paper

More papers in Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research Contact information at EDIRC.
Bibliographic data for series maintained by Bibliothek (bibliothek@diw.de).