A new measure of the output gap, inflation dynamics, and the New Keynesian Phillips Curve

Abstract

Literature suggests that measures of slack such as unemployment, output, labour share, and inflation have been separated in recent years, particularly after the global crisis. Some claimed that the Phillips curve had vanished. Because of the unobservable nature of the natural rates, estimation of the output and unemployment gaps might not offer precise outcomes. The inflation model permits a fraction of firms that use a backwards-looking rule to set prices, as Gali and Gertler (2000) did. The essential contrast between their paper and mine is that they utilized marginal cost estimates as the applicable determinant of inflation, and I utilized the estimated output gap. Gali and Gertler supposed real marginal costs are a significant determinant of inflation. They also believed the output gap was negative and inconsequential. I have indicated that a precise output gap estimate is significant and positive. CBO output gap is also used to inspect for robustness. However, it was also insignificant, as the literature suggests. Therefore, the model used the estimated output gap instead of marginal cost. I calculated the output gap with a new methodology and could replicate their results with the new measure. I extended their study to 2019Q4; It is showed that their measure for inflation slack which was marginal cost becomes insignificant; however, my measure of the output gap is still significant. Therefore, it was inferred that the New Keynesian Phillips curve reasonably still explains inflation dynamics. I also concluded that the hybrid new Keynesian Phillips curve might explain the inflation dynamics.