Modeling the Phillips curve with unobserved components

Andrew C. Harvey

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: The relationship between in.ation and the output gap can be modeled simply and effectively by including an unobserved random walk component in the model. The dynamic properties match the stylized facts and the random walk component satisfies the properties normally required for core in.ation. The model may be generalized to as to include a term for the expectation of next period's output, but it is shown that this is difficult to distinguish from the original specification. The model is fited as a single equation and as part of a bivariate model that includes an equation for GDP. Fitting the bivariate model highlights some new aspects of unobserved components modeling. Single equation and bivariate models tell a similar story: an output gap two per cent above trend is associated with an annual inflation rate that is one percent above core inflation.

Keywords: Cycle; hybrid new Keynesian Phillips curve; inflation gap; Kalman filter, output gap. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ecm, nep-ets and nep-mac
Date: 2008-01
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