Fundamental Inflation Uncertainty
23 Pages Posted: 27 Feb 2007
Date Written: October 2006
We develop a method of quantifying the uncertainty surrounding the estimates of the fundamental inflation implied by the New Keynesian Phillips Curve (NKPC). The uncertainty is represented as a band around the fundamental inflation, and encompasses the sampling uncertainty of both the estimates of the structural parameters and the estimates of the VAR used to form a projection of real marginal costs. An empirical application on UK and US data confirms that fundamental inflation tracks actual inflation reasonably well in both countries. For the United Kingdom the confidence band is sufficiently narrow, relative to the sample variance of inflation, to identify a number of periods where the predictions of the NKPC do not fully capture movements in actual inflation. In contrast, considerable uncertainty surrounds the estimates of fundamental inflation for the United States.
Keywords: Sampling uncertainty, New Keynesian Phillips Curve, fundamental inflation, two-step minimum distance
JEL Classification: E38, E52
Suggested Citation: Suggested Citation