Is the Backward-Looking Component Important in a New Keynesian Phillips Curve?

Abstract

New Keynesian Phillips curves (NKPC) have recently been modified to include additionallagsofinflationinthespecificationinordertocapturetheconsiderablepersistenceinpostwarU.S.inflation. Furthermore, many researchers have agreed on the existence of structural changes in thepersistence of inflation. Continuing with these literatures, we investigate the nature of structuralchanges in the hybrid NKPC and reconsider the role of the backward-looking component in theNKPC, taking into account the possibility of structural changes in the steady-state inflation rate.Our empirical results show multiple structural breaks in the NKPC in 1974 and 1982. Accountingfor these structural changes, the backward-looking component is no longer significant throughoutthe whole sample period. In other words, the significant role of the backward-looking componentin the earlier literature might be spuriously capturing the structural changes in the steady-stateinflation rate. Thus, U.S. inflation dynamics are well explained by a pure NKPC if we take intoaccount the possibility of structural changes in the steady-state inflation rate.