Estimates of the New Keynesian Phillips Curve for Pakistan

Abstract

This paper presents estimates of the New Keynesian Phillips Curve (NKPC) for the agriculture, manufacturing and services sectors of Pakistan’s economy. The real marginal cost—derived from dynamic translog cost function—labour share of income and output gap are the indicators of economic activity along with past and expected inflation to determine inflation dynamics in each sector. The estimates of the structural parameters of the NKPC are consistent with economic theory in most of the models. Within-sample forecast performance and diagnostic tests indicate that the derived measure of real marginal cost performs better relative to the specifications with labour share of income or output gap. Further, the NKPC based on restrictive Cobb–Douglas production technology with labour input only does not perform better than the models that considers more inputs and intermediate cost. Our results show that the manufacturing is forward-looking sector followed by services and agriculture sectors.