Trend Inflation and Inflation Persistence in the New Keynesian Phillips Curve

40 Pages Posted: 6 Dec 2006

See all articles by Timothy Cogley

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics

Argia M. Sbordone

Federal Reserve Bank of New York

Date Written: December 2006

Abstract

The New Keynesian Phillips curve (NKPC) asserts that inflation depends on expectations of real marginal costs, but empirical research has shown that purely forward-looking versions of the model generate too little inflation persistence. In this paper, we offer a resolution of the persistence problem. We hypothesize that inflation is highly persistent because of drift in trend inflation, a feature that many versions of the NKPC neglect. We derive a version of the NKPC as a log-linear approximation around a time-varying inflation trend and examine whether it explains deviations of inflation from that trend. We estimate the NKPC parameters jointly with those that define the inflation trend by estimating a vector autoregression with drifting coefficients and volatilities; the autoregressive parameters are constrained to satisfy the restrictions imposed by the NKPC. Our results suggest that trend inflation has been historically quite volatile and that a purely forward-looking model that takes these fluctuations into account approximates well the short-run dynamics of inflation.

Keywords: inflation persistence, Phillips curve, time-varying VAR

JEL Classification: E31

Suggested Citation

Cogley, Timothy and Sbordone, Argia M., Trend Inflation and Inflation Persistence in the New Keynesian Phillips Curve (December 2006). FRB of New York Staff Report No. 270, Available at SSRN: https://ssrn.com/abstract=949609 or http://dx.doi.org/10.2139/ssrn.949609

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
530-752-1581 (Phone)
530-752-9382 (Fax)

Argia M. Sbordone (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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