Abstract
In this paper, we propose an expanded version of the hybrid NKPC by incorporating the extrapolative price-setting mechanism in the backward-looking part. We assume that when firms set the price at time t, they use information on the price in period t−1 plus a portion of change in prices between t−1 to t−2 (a partial error correction). Under this expanded setting, we explicitly derive both structural and reduced-form NKPCs. The empirical results show that the extrapolative component is strongly significant in explaining inflation dynamics. In addition, the expanded version of the hybrid NKPC exhibits a better empirical performance than the original hybrid NKPC proposed by Galí and Gertler (1999) in terms of various statistical criteria.
Published Version
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