Is there a phillips curve in Canada? A rational expectations approach

Abstract

Most recent empirical studies of the expectations-augmented Phillips curve for Canada support the re-emergence of the short-run Phillips curve whose existence had been cast in doubt by the results of earlier studies covering the post-1967 period. Moreover, these studies find that the long-run Phillips curve is vertical in Canada. In this paper, using standard micro underpinnings, we derive an expression for excess demand in the labor market that incorporates only observable variables. Further, we assume that expectations are rational. Our empirical results indicate that rationality does not wipe out the short-run Phillips curve and interestingly it also allows a long-run trade-off between excess demand for labor and inflation. The latter finding suggests that caution should be exercised in attempting to estimate the Canadian natural rate of unemployment.