Monetary Policy Shifts and Inflation Dynamics

31 Pages Posted: 31 Mar 2008

See all articles by Paolo Surico

Paolo Surico

London Business School - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: January 2008

Abstract

The New Keynesian Phillips Curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various post-war full samples. While it is well known that in a standard sticky price model a 'weak' central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for (i) the estimates of the structural Phillips curve and (ii) the estimates of inflation persistence had not been investigated. Using Monte Carlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the process of inflation. On the reduced form, our results show that inflation persistence can be endogenous to the policy regime rather than intrinsic to the structure of the economy. On the structural form, we find that by neglecting equilibrium indeterminacy the estimates of the forward-looking term of the New Keynesian Phillips Curve are biased downward. The implications are in line with the empirical evidence for the United Kingdom and United States.

Keywords: Indeterminacy, New Keynesian Phillips Curve, Monte Carlo, bias, persistence

JEL Classification: E58, E31, E32

Suggested Citation

Surico, Paolo, Monetary Policy Shifts and Inflation Dynamics (January 2008). Bank of England Working Paper No. 338. Available at SSRN: https://ssrn.com/abstract=1114055 or http://dx.doi.org/10.2139/ssrn.1114055

Paolo Surico (Contact Author)

London Business School - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://sites.google.com/site/paolosurico

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