Trend Inflation and the Nature of Structural Breaks in the New Keynesian Phillips Curve

Chang-Jin Kim (), Pym Manopimoke () and Charles Nelson
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Pym Manopimoke: Department of Economics, University of Kansas

No 1305, Discussion Paper Series from Institute of Economic Research, Korea University

Abstract: In this paper, we investigate the nature of structural breaks in inflation by estimating a version of the New Keynesian Phillips curve (NKPC) in the presence of a unit root in inflation. We show that, with a unit root in inflation, the NKPC implies an unobserved components model that consists of three components: a stochastic trend component, a component that depends upon current and future forecasts of real economic activity, and a stationary component which is potentially serially correlated (or a component of inflation that is not explained by the conventional forward-looking NKPC). Our empirical results suggest that, with an increase in trend inflation during the Great Inflation period, the response of inflation to real economic activity decreases and the persistence of the inflation gap increases due to an increase in the persistence of the unobserved stationary component. These results are in line with the predictions of Cogley and Sbordone (2008), who show that the coefficients of the NKPC are functions of time-varying trend inflation.

Keywords: New Keynesian Phillips Curve; Trend Inflation; Inflation Gap; Unobserved Components Model; Structural Breaks (search for similar items in EconPapers)
JEL-codes: C32 E12 E31 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-mac
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Working Paper: Trend Inflation and the Nature of Structural Breaks in the New Keynesian Phillips Curve (2013)
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