The New Keynesian Phillips Curve Tested on OECD Panel Data

Abstract

Using a panel data set for OECD countries we replicate the typical features of the New Keynesian Phillips curve models (NPCs) that have been estimated on country data. While this corroborates the NPC also on the macro panel data set, a different conclusion is reached when we test whether the NPC encompasses an existing model of inflation which is without feed-forward terms, but which allows for other adjustment factors than the NPC. We find that the NPC?s expected rate of future inflation and real marginal costs are weak explanatory variables, and that their statistical significance in the typical NPC is due to correlation with the equilibrium correction terms that are implied by the existing inflation model. Our results are in line with the relatively few encompassing studies that exist on country and area data. --New Keynesian Phillips curve,forward-looking price setting,panel data model,encompassing

Interpreting the evidence for New Keynesian models of inflation dynamics

“…Regarding the prevalence of forward-lookingness, Bårdsen et al (2004) and Bjørnstad and Nymoen (2008) test the encompassing capability of the NKPC with respect to competing models of in ‡ation dynamics and …nd that forward-dominance may be a spurious …nding. Castle et al (2010) show theoretically how forward dominance may be a result of intermittent structural breaks.…”

Determinants of inflation differentials in the euro area: Is the New Keynesian Phillips Curve enough?

“…4 When estimating equation (1), data poolability was assumed, i.e., that equation's coeffi-cients are the same for all countries. As highlighted by Bjornstad and Nymoen (2008), this assumption has the advantage of bringing efficiency gains. In the euro area, the assumption of poolability makes sense as countries in that area are relatively homogeneous, because they have been converging in nominal and real terms and share similar monetary and fiscal policy frameworks.…”

“…Therefore, we used as instruments two lags of inflation rate, a dummy variable, one lag of the change in exchange rate, output gap, interest rate and price level. 7 We added some additional instruments that proved to have a strong explanatory power in the first stage regression: CPI lagged two periods, one lag of the change in import prices and real exchange rate. 8 One point worth testing when choosing instruments is their weakness, since weak instruments are common in forward-looking models with rational expectations (Mavroeidis, 2004).…”

“…7 The dummy variable was introduced to accommodate the fact that retail interest rates were not harmonised before 2003Q1 (see Section 7). 8 There are some small changes in instruments depending on the exact specification of the estimated equation.…”

Determinants of Inflation Differentials in the Euro Area: Is the New Keynesian Phillips Curve Enough?

“…The open economy NKPC can be expressed in an error correction model of the price level, similar to (7). The initial equation is:…”