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Identification of New Keynesian Phillips Curves from a Global Perspective

41 Pages Posted: 12 Feb 2008  

Stephane Dees

European Central Bank (ECB)

M. Hashem Pesaran

USC Dornsife Institute for New Economic Thinking; University of Southern California; Trinity College, Cambridge

L. Vanessa Smith

University of York

Ron Smith

Birkbeck College

Multiple version iconThere are 2 versions of this paper

Date Written: February 2008

Abstract

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 inflation in terms of the observables. In practice, the equation is estimated by 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

JEL Classification: C32, E17, F37, F42

Suggested Citation

Dees, Stephane and Pesaran, M. Hashem and Smith, L. Vanessa and Smith, Ron, Identification of New Keynesian Phillips Curves from a Global Perspective (February 2008). CESifo Working Paper Series No. 2219; IEPR Working Paper No. 08.1; ECB Working Paper No. 892. Available at SSRN: https://ssrn.com/abstract=1092411

Stephane Dees

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

M. Hashem Pesaran (Contact Author)

USC Dornsife Institute for New Economic Thinking ( email )

3620 S. Vermont Avenue, KAP 364F
Los Angeles, CA 90089-0253
United States

University of Southern California ( email )

Los Angeles, CA 90089
United States

Trinity College, Cambridge ( email )

United Kingdom

L. Vanessa Smith

University of York ( email )

York, YO10 5DD
United Kingdom

Ron P. Smith

Birkbeck College ( email )

Malet Street
London WC1E 7HX
United Kingdom
+44 207 631 6413 (Phone)
+44 207 631 6416 (Fax)

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