Deep Habits in the New Keynesian Phillips Curve

39 Pages Posted: 18 Dec 2012

See all articles by Thomas Lubik

Thomas Lubik

Federal Reserve Banks - Federal Reserve Bank of Richmond

Wing Leong Teo

University of Nottingham

Multiple version iconThere are 3 versions of this paper

Date Written: November 1, 2011

Abstract

We derive and estimate a New Keynesian Phillips curve (NKPC) in a model where consumers are assumed to have deep habits. Habits are deep in the sense that they apply to individual consumption goods instead of aggregate consumption. This alters the NKPC in a fundamental manner as it introduces expected and contemporaneous consumption growth as well as the expected marginal value of future demand as additional driving forces for inflation dynamics. We construct the driving process in the deep habits NKPC by using the model's optimality conditions to impute time series for unobservable variables. The resulting series is considerably more volatile than unit labor cost. General Methods of Moments (GMM) estimation of the NKPC shows an improved fit and a much lower degree of indexation than in the standard NKPC. Our analysis also reveals that the crucial parameters for the performance of the deep habit NKPC are the habit parameter and the substitution elasticity between differentiated products. The results are broadly robust to alternative specifications.

Keywords: Phillips curve, GMM, marginal costs, deep habits

JEL Classification: E31, E32

Suggested Citation

Lubik, Thomas and Leong Teo, Wing, Deep Habits in the New Keynesian Phillips Curve (November 1, 2011). Available at SSRN: https://ssrn.com/abstract=2190611 or http://dx.doi.org/10.2139/ssrn.2190611

Thomas Lubik (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Wing Leong Teo

University of Nottingham ( email )

University Park
Nottingham, NG8 1BB
United Kingdom

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