Abstract
In deriving the hybrid new Keynesian Phillips curve (HNKPC) in Galí and Gertler (1999) and Holmberg (2006), it is assumed that backward-looking firms index their prices to the average prices newly set last period plus last period’s inflation rate, resulting in a Phillips curve equation that relates current inflation to a demand variable, expected future inflation, and last period’s inflation. The present study generalizes the derivation of the HNKPC to allow firms to index prices to multiple lags of inflation, resulting in a HNKPC in which current inflation depends on multiple lags of inflation instead of only one lag of inflation, providing theoretical justification for empirical specifications of the HNKPC that include more than one lag of inflation.
Highlights
IntroductionThe hybrid new Keynesian Phillips curve (HNKPC) is generally expressed as an equation that relates current inflation to a real demand variable (usually either the output gap or real marginal cost), period’s inflation, and last period’s inflation
The hybrid new Keynesian Phillips curve (HNKPC) is generally expressed as an equation that relates current inflation to a real demand variable, period’s inflation, and last period’s inflation
In deriving the hybrid new Keynesian Phillips curve (HNKPC) in Galí and Gertler (1999) and Holmberg (2006), it is assumed that backward-looking firms index their prices to the average prices newly set last period plus last period’s inflation rate, resulting in a Phillips curve equation that relates current inflation to a demand variable, expected future inflation, and last period’s inflation
Summary
The hybrid new Keynesian Phillips curve (HNKPC) is generally expressed as an equation that relates current inflation to a real demand variable (usually either the output gap or real marginal cost), period’s inflation, and last period’s inflation. Of the firms that can reset prices in a given period, a fraction set their price at a level that maximizes the present value of expected profits, while the remainder index their prices to the average price chosen by firms that reset prices in the previous period, adjusted for last period’s inflation rate. The former are considered forward-looking firms, and the latter are considered backward-looking firms. The equation derived in the present study provides theoretical justification for empirical estimates of the HNKPC that include more than one lag of inflation
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