Inflation Dynamics: The Role of Expectations
28 Pages Posted: 26 Jul 2006
Date Written: May 2006
The modelling of expectations and its degree of backward looking behaviour are issues of main concern in the inflation dynamics research agenda. One approach in the literature is to use expectations from surveys as an approximation to actual expectations. We estimate the Phillips curve allowing for a simultaneous role of rational and survey expectations. We formulate both a generalization of the usual Phillips curve and a structural version in the spirit of Galí and Gertler (1999). We find that marginal cost determines inflation while the role of detrended output appears to be problematic. We also find that survey expectations are an important component of inflation dynamics but they do not fully reflect economic agents' rationality. A significant level of rationality is found even when controlling for survey expectations. Our results suggest that taking survey expectations as representative of actual expectations is a doubtful methodology.
Keywords: Inflation; Phillips curve; Marginal cost; Survey Expectations
JEL Classification: E31
Suggested Citation: Suggested Citation