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Observed Inflation Forecasts and the New Keynesian Phillips Curve

Chengsi Zhang (), Denise Osborn () and Dong Heon Kim ()

No 801, Discussion Paper Series from Institute of Economic Research, Korea University

Abstract: Empirical estimations of the micro-founded New Keynesian Phillips Curve (NKPC) using rational inflation expectation proxies have often found that the output gap is an invalid measure of inflation pressure. This paper investigates the empirical success of the NKPC in explaining US inflation when observed measures of inflation expectations are used in conjunction with the output gap. The paper also contributes to the literature by addressing the important problem of serial correlation in the stylized NKPC and developing an extended model to account for this serial correlation. Contrary to recent results indicating no role for the output gap, we find it to be a statistically significant driving variable for inflation, with this finding robust to whether the inflation expectations series used relates to individual consumers, professional forecasters or the US Fed. In most of our estimations, however, lagged inflation dominates the role of inflation expectations, casting doubt on the extent to which price setting is forward-looking over the period 1968 to 2005. From an econometric perspective, the paper uses GMM estimation to account for endogeneity while also addressing concerns raised in recent studies about weak instrumental variables used in estimating NKPC models.

Keywords: New Keynesian Phillips Curve; serial correlation; GMM; inflation forecasts (search for similar items in EconPapers)
JEL-codes: E31 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2008
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Related works:
Journal Article: Observed Inflation Forecasts and the New Keynesian Phillips Curve* (2009) Downloads
Working Paper: Observed Inflation Forecasts and the New Keynesian Phillips Curve (2006) Downloads
Working Paper: Observed Inflation Forecasts and the New Keynesian Phillips Curve (2006) Downloads
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