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

Kim, Chang-Jin and Manopimoke, Pym and Nelson, Charles (2013): Trend Inflation and the Nature of Structural Breaks in the New Keynesian Phillips Curve. Forthcoming in: Journal of Money, Credit, and Banking

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: New Keynesian Phillips Curve, Trend Inflation, Inflation Gap, Unobserved Components Model, Structural Breaks
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation

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