The Phillips Curve Under State-Dependent Pricing

Bank of England Working Paper No. 227

38 Pages Posted: 4 Jan 2005

See all articles by Hasan Bakhshi

Hasan Bakhshi

Bank of England - Monetary Analysis

Hashmat Khan

Bank of England - Structural Economic Analysis Division

Barbara Rudolf

Swiss National Bank

Date Written: August 2004

Abstract

This paper is related to a large recent literature studying the Phillips curve in sticky-price equilibrium models. It differs in allowing for the degree of price stickiness to be determined endogenously. A closed-form solution for short-term inflation is derived from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing originally developed by Dotsey, King and Wolman. This generalised Phillips curve encompasses the New Keynesian Phillips curve (NKPC) based on Calvo-type price-setting as a special case. It describes current inflation as a function of lagged inflation, expected future inflation, and current and expected future real marginal costs. The paper demonstrates that inflation dynamics generated by the model for a broad class of time and state-dependent price-setting behaviours are well approximated by the popular hybrid NKPC (with one lag of inflation) in a low-inflation environment. This provides an explanation of why the hybrid NKPC performs well in describing inflation dynamics across industrial countries. It implies, however, that the reduced-form coefficients of the hybrid NKPC may not have a structural interpretation.

Keywords: Trend inflation, state-dependent pricing, Phillips curve

JEL Classification: E31

Suggested Citation

Bakhshi, Hasan and Khan, Hashmat and Rudolf, Barbara, The Phillips Curve Under State-Dependent Pricing (August 2004). Bank of England Working Paper No. 227, Available at SSRN: https://ssrn.com/abstract=641283 or http://dx.doi.org/10.2139/ssrn.641283

Hasan Bakhshi

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom
020 7601 5996 (Phone)

Hashmat Khan (Contact Author)

Bank of England - Structural Economic Analysis Division ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Barbara Rudolf

Swiss National Bank ( email )

Borsenstrasse 15
CH-8022 Zurich
Switzerland

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