Introducing price-setting behaviour in the Phillips Curve: the role of nonlinearities

Saglio, Sophie and López-Villavicencio, Antonia (2012): Introducing price-setting behaviour in the Phillips Curve: the role of nonlinearities.

Abstract

Based on the theoretical literature on price setting behavior, we model three distinct forms of nonlinearity that can describe the reduced-form Phillips curve: reaction asymmetry, state dependence and a mix of both. Employing these models to the G5 for the 1985-2011 period, we find that: (i) the Phillips curve is unstable and nonlinear and (ii) there exist threshold levels of inflation and capacity utilization that erode price rigidity. Our results reinforce the existence of downward price rigidity in Japan, helping to explain the puzzle of gradual deflation. In opposition, downward price flexibility is verified for U.S.

• Item Type: MPRA Paper
• Language: English
• Keywords: Phillips Curve, deflation, rigidity, capacity constraint, non-linearity
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C51 - Model Construction and Estimation; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation

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