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Abstract not found

New Keynesian Phillips Curves (NKPC) have been extensively used in the analysis of monetary policy, but yet there are a number of issues of concern about how they are estimated and then related to the underlying macroeconomic theory. The first is whether such equations are identified. To check identification requires specifying the process for the forcing variables (typically the output gap) and solving the model for inflationintermsoftheobservables. Inpractice,theequationisestimatedby GMM, relying on statistical criteria to choose instruments. This may result in failure of identification or weak instruments. Secondly, the NKPC is usually derived as a part of a DSGE model, solved by log-linearising around a steady state and the variables are then measured in terms of deviations from the steady state. In practice the steady states, e.g. for output, are usually estimated by some statistical procedure such as the Hodrick-Prescott (HP) filter that might not be appropriate. Thirdly, there are arguments that other variables, e.g. interest rates, foreign inflation and foreign output gaps should enter the Phillips curve. This paper examines these three issues and argues that all three benefit from a global perspective. The global perspective provides additional instruments to alleviate the weak instrument problem, yields a theoretically consistent measure of the steady state and provides a natural route for foreign inflation or output gap to enter the NKPC. Keywords: Global VAR (GVAR), identification, New Keynesian Phillips Curve, Trend-Cycle decomposition.

Abstract: We use the inflation premium—the difference between nominal and real interest rates—as a proxy for expected inflation in the context of the New Keynesian Phillips Curve. Using data from inflation-indexed and nominal bonds we estimate a forward-looking Phillips curve for the United Kingdom over the period 1985-2004. The proposed model describes UK inflation dynamics considerably better than does the standard hybrid New Keynesian Phillips Curve under the assumption of rational expectations. In contrast with the findings in the rest of the literature we find that there still exists a tradeoff between inflation and the stance of the real economy, regardless of the empirical measure used. This relationship also persists in the period since the UK adopted inflation targeting as a framework for monetary policy.

Abstract not found

Bank of Canada working papers are theoretical or empirical works-in-progress on subjects in economics and finance. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada. 2 ISSN 1701-9397

Bank of Canada working papers are theoretical or empirical works-in-progress on subjects in economics and finance. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada. 2

One result from a rather large literature on optimal monetary policy is that central bankers can obtain better outcomes on average if they have a good understanding of what determines economic behaviour and, importantly, inflation dynamics. For instance, after a shock, policy responses to bring

We develop methods for testing the hypothesis that an econometric model is underidentified and inferring the nature of the failed identification. By adopting a generalizedmethod-of moments perspective, we feature directly the structural relations and we allow for nonlinearity in the econometric specification. We establish the link between a test for overidentification and our proposed test for underidentification. If, after attempting to replicate the structural relation, we find substantial evidence against the overidentifying restrictions of an augmented model, this is evidence against underidentification of the original model. 1

The relationship between in‡ation and the output gap can be modeled simply and e¤ectively by including an unobserved random walk component in the model. The dynamic properties match the stylized facts and the random walk component satis…es the properties normally required for core in‡ation. The model may be generalized to as to include a term for the expectation of next period’s output, but it is shown that this is di ¢ cult to distinguish from the original speci…cation. The model is …tted as a single equation and as part of a bivariate model that includes an equation for GDP. Fitting the bivariate model highlights some new aspects of unobserved components modeling. Single equation and bivariate models tell a similar story: an output gap two per cent above trend is associated with an annual in‡ation rate that is one percent above core in‡ation.