Trend inflation and inflation persistence in the New Keynesian Phillips Curve

Timothy Cogley () and Argia Sbordone ()

No 270, Staff Reports from Federal Reserve Bank of New York

Abstract: The New Keynesian Phillips curve (NKPC) asserts that inflation depends on expectations of real marginal costs, but empirical research has shown that purely forward-looking versions of the model generate too little inflation persistence. In this paper, we offer a resolution of the persistence problem. We hypothesize that inflation is highly persistent because of drift in trend inflation, a feature that many versions of the NKPC neglect. We derive a version of the NKPC as a log-linear approximation around a time-varying inflation trend and examine whether it explains deviations of inflation from that trend. We estimate the NKPC parameters jointly with those that define the inflation trend by estimating a vector autoregression with drifting coefficients and volatilities; the autoregressive parameters are constrained to satisfy the restrictions imposed by the NKPC. Our results suggest that trend inflation has been historically quite volatile and that a purely forward-looking model that takes these fluctuations into account approximates well the short-run dynamics of inflation.

Keywords: Phillips curve; Inflation (Finance) (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-mon
Date: 2006
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