Keynesian Phillips Curve Research Articles

Greenflation, a myth or fact? Empirical evidence from 26 OECD countries

Among the various effects of the green transition on the macroeconomy, we examined the unintended effects of the green transition on inflation, the so-called “greenflation”. We analyzed panel data from 26 OECD countries covering the period from 2005 to 2019 using four models based on the New Keynesian Phillips curve model. To date, only a few studies have examined greenflation, particularly in terms of empirical investigation. The main contribution of this study to the literature is to provide empirical evidence of greenflation. We also provide empirical evidence on the issues in the NKPC literature that the output gap better explains inflation dynamics than unit labor costs and confirm the demise of the Phillips curve. Estimates from the Common Correlated Effect Mean Group (CCEMG), Augmented Mean Group (AMG), and Panel Corrected Standard Error (PCSE) models indicate that the green transition has an upward inflationary impact on headline inflation, but no significant impact on core inflation. In addition, we have examined four circumstances under which the green transition may affect inflation that have not been sufficiently discussed in the literature: increased green transition spending, carbon pricing, increased demand for critical minerals, and the low energy density of renewable energy. Each of these circumstances has the potential to exert both upward and downward pressures simultaneously. Our suggestion to policymakers is that they do not yet need to change their current view of monetary policy with respect to greenflation, but they should carefully consider policy designs that take into account the unintended effects of the energy transition.

The art of paradigm maintenance: how the New Keynesian ‘Science of Monetary Policy’ tries to deal with the inflation of 2021–2023

The macroeconomic models used by major institutions including the Federal Reserve and the International Monetary Fund (IMF) failed to predict the inflation surge during 2021–2023. The output gap, the unemployment gap, the New Keynesian Phillips curve and inflation expectations did not give timely and relevant signals. The re-emergence of inflation thus threw the ‘science of monetary policy’ off the rails. Faced with the choice between changing their paradigm and proving that there is no need to do so, the ‘scientists of monetary policy’ got busy on the proof. As a result, a number of ad hoc epicycles have been added to the New Keynesian analytical core – with the help of which one can claim to be able to explain the sudden acceleration of inflation post factum. This paper critically reviews the theoretical and empirical merits of three recent tweaks to the New Keynesian core: using the vacancy ratio as the appropriate measure of real economic activity; hammering on the considerable risk of an imminent wage–price spiral; and the resurrection of the non-linear Phillips curve. The paper concludes by drawing out sobering lessons concerning the art of paradigm maintenance as practiced by the ‘scientists of monetary policy’.

The New Keynesian Phillips Curve and r* ${r}^{* }$

AbstractIn this article, I argue that shifts in the natural rate of interest provide important insights for the New Keynesian Phillips Curve (NKPC). The deviation of the real interest rate from the natural interest rate (interest rate gap) captures the monetary policy stance, which is important for the dynamics of inflation and the output gap in the wake of persistent and permanent variation in the natural rate of interest. I present the evolution of the estimates of the Taylor‐rule consistent‐ natural interest rate, and thus the associated path of the expectations of future inflation via the Fisherian relationship. The path of these two variables has implications for estimation of the NKPC.

Examining the New Keynesian Phillips Curve in the U.S.: Why has the relationship between inflation and unemployment weakened?

This paper conducts a comprehensive review of the relationship between inflation and unemployment in the U.S. as described by the Phillips curve in a New Keynesian framework and investigates whether this relationship has changed systematically over time. We also aim to identify possible explanations for these changes. Three different hypotheses are discussed to assess whether they are consistent with more recent developments, such as the evolution of inflation expectations, the impact of globalization, and possible nonlinearities in the functional shape of the Phillips curve. We find that the relationship between inflation and unemployment has weakened since the 1980s and especially during the Covid-19 pandemic due to forces of globalization and better anchored inflation expectations resulting from more credible monetary policy. This has led to question of whether the Phillips curve is outdated. We conclude with the implications of these findings for the conduct of monetary policy.

Effects of supply chain bottlenecks and fiscal stimulus on inflation dynamics in the COVID-19 pandemic era: a case of South Korea*

ABSTRACT We employ an augmented New Keynesian Phillips curve, integrating a global supply chain bottleneck index and comprehensive fiscal stimulus packages, to quantitatively examine the impact of these variables on inflation rates in South Korea using monthly time-series data from 2010 to 2023. The results reveal three key findings. First, the Global Supply Chain Pressure Index (GSCPI), serving as a proxy for global supply chain bottlenecks, has an overall statistically insignificant effect on inflation throughout the observation period. However, during the pandemic, its effect on inflation was statistically significant. Second, the detrended government stimulus packages, proxied by government transfers or government fixed investment, also demonstrated a significant escalating effect on inflation during the pandemic. These findings suggest that both cost-push and demand-pull factors contributed to recent inflation surges. Third, conventional determinants of inflation, such as expected inflation, the domestic output gap, and crude oil prices, consistently influence inflation, aligning with existing literature.

Pass-through of oil prices to Brazilian inflation: An analysis between 2014 and 2023

ABSTRACT The price of fuels, and consequently, the price of oil, is one of the elements of historical relevance for the general price level that the Brazilian population faces, given the country’s dependency on the road transportation mode for product distribution and the potential ripple effects that the oil price naturally exerts on other sectors of the economy. Therefore, the aim of the present study is to quantify the influence of oil prices on the overall price index of the Brazilian economy for the period between January 2014 and May 2023. To achieve this objective, a model based on a hybrid New Keynesian Phillips curve was constructed, and the estimation was performed using Structural Vector Error Correction (SVEC) models. As a result, we find that, although oil prices are not the most significant drivers of inflation, their influence is present, positive, and persists for a considerable number of periods.

Forecasting Inflation with the New Keynesian Phillips Curve: Frequencies Matter*

AbstractWe forecast US inflation with a new Keynesian Phillips curve (NKPC) in the frequency domain. Our method consists of decomposing the time series of inflation and its NKPC predictors into several frequency bands, forecasting separately each frequency component of inflation, and then summing up those forecasts to obtain the forecast for aggregate inflation. We find that (i) accurately forecasting the low frequency of inflation is, on average, crucial to successfully forecast inflation; (ii) our NKPC low‐frequency forecast model consistently and significantly outperforms the time‐series NKPC and standard benchmark models; (iii) the low frequencies of inflation expectations and unemployment are the key predictors; and (iv) optimally switching on / off the forecasts of each frequency components of inflation at each period allows to outstandingly track inflation and show that all frequencies of inflation matter.

A Factor‐Augmented New Keynesian Phillips Curve for the European Union Countries

AbstractIn this paper, a factor‐augmented version of the New Keynesian Phillips curve (NKPC) is assessed using a data set comprised of a large panel of European Union (EU) member countries. The factor‐augmentation is natural given that country‐level inflation rates are highly co‐moving. The presence of unattended common factors is important because it raises the issue of omitted variables bias, as the real marginal cost, which is a regressor of the NKPC, is likely to load on the same factors as inflation. One possibility here is to employ the regular instrumental variables approach. However, if the external instruments load on the same factors as the error term of the NKPC, the instruments would be invalid and the results would therefore likely be misleading. Motivated by this last observation, the present paper proposes a new estimator of the NKPC that allows for very general forms of factor dependencies and endogeneity. Our results provide evidence in support of the NKPC, but only after the presence of common factors has been appropriately accounted for.

Factor IV Estimation in Conditional Moment Models with an Application to Inflation Dynamics

Abstract In a conditional moment model, we develop a new integrated conditional moment (ICM) estimator which directly exploits factor-based conditional moment restrictions without having to first parametrize, or estimate such restrictions. We focus on a time series framework where the large number of available instruments and associated lags is driven by a relatively small number of unobserved factors. We build on the ICM principle originally proposed by Bierens (1982) and combine it with information reduction methods to handle the large number of potential instruments which may exceed the sample size. Under the maintained validity of the true factors, but not that of observed instruments, and standard regularity assumptions, our estimator is consistent, asymptotically normally distributed, and easy to compute. In our simulation studies, we document its reliability and power in cases where the underlying relationship between the endogenous variables and the instruments may be heterogeneous, non-linear, or even unstable over time. Our estimation of the New Keynesian Phillips curve with U.S. data reveals that forward- and backward-looking behaviors are quantitatively equally as important, while the driver’s role is nil.

The unemployment–inflation trade-off revisited: The Phillips curve in COVID times

Using a New Keynesian Phillips curve, we document the rapid and persistent increase in the natural rate of unemployment, ut∗, in the aftermath of the pandemic and characterize its implications for inflation dynamics. While the bulk of the inflation surge is attributed to temporary supply factors, we also find an important role for current and expected negative unemployment gaps. Through the lens of the model, the 2022–2023 disinflation was driven by the expectation that the unemployment gap will close through a progressive decline in ut∗ and a rise in the unemployment rate. This implies that convergence to long-run price stability depends, critically, on expectations about labor market tightness. Using a variety of cross-sectional data sources we provide corroborating evidence of unusually tight labor market conditions, consistent with our estimated rise in ut∗.

The Estimation of Traditional Phillips Curve

This article presents theoretical foundations for original Phillips curve formulation and an empirical investigation, where the structure of the theoretical model serves as a template for the creation of the empirical model.For a couple of decades the majority of empirical Phillips curve type assessments are performed using the New Keynesian Phillips curve with Calvo pricing as a benchmark for this type of relationship. New Keynesian model has solid microeconomic foundations, has proved itself very well in the analysis of price stickiness; nevertheless, it is not without limitations. The main insufficiency of New Keynesian model is that it has no direct links to the conditions and the changes that occur in the labour market. The need to encompass the conditions in labour market comes from the coincides that occur time to time when the growth rates of aggregate production may diminish or even become negative, but the level of employment may stay the same, what in turn means that the pressure on inflation won’t drop, despite the fact that production level has not increased as expected or even has decreased. This article aims to fill this gap and presents alternative theoretical foundations for Phillips curve, that lead to the model with direct links to the labour market. Theoretical foundations are necessary as they may help to minimize the risks to miss some important details or to omit important factors. Although the empirical analysis in this paper is based on Lithuanian data, it is not country specific.

New Pricing Models, Same Old Phillips Curves?

Abstract We show that in a broad class of menu cost models, the first-order dynamics of aggregate inflation in response to arbitrary shocks to aggregate costs are nearly the same as in Calvo models with suitably chosen Calvo adjustment frequencies. We first prove that the canonical menu cost model is first-order equivalent to a mixture of two time-dependent models, which reflect the extensive and intensive margins of price adjustment. We then show numerically that in any plausible parameterization, this mixture is well approximated by a single Calvo model. This close numerical fit carries over to other standard specifications of menu cost models. Thus, for shocks that are not too large, the Phillips curve for a menu cost model looks like the New Keynesian Phillips curve, but with a higher slope.

Inflation dynamics in the frequency domain

We use a New Keynesian Phillips Curve to study the dynamics of inflation in the frequency domain. Inflation expectations dominate medium-to-long-run cycles, energy inflation dominate short cycles and also longer cycles once expectations became anchored. While statistically significant, unemployment is not economically relevant at any frequency band.

Asymmetric new Keynesian Phillips curve for Mexico, 2005Q1–2022Q4

PurposeThe labor market responds in a differentiated manner during recessions and expansions, and it is of vital importance to know the magnitude asymmetries. The purpose of this paper is to evaluate the effects of the disinflationary monetary policy (2005Q1–2022Q4) through the sacrifice rate measured in terms of unemployment and rate of critical labor conditions (RCLC) with nonlinear auto regressive distributed lag (NLARDL; Shin et al., 2014), which allows to efficiently estimate asymmetric effects in short and long terms in the presence of variables of different integration orders.Design/methodology/approachThe authors estimate an asymmetric accelerationist Phillips curve, augmented with labor precariousness for Mexico (2005Q1–2022Q4) following the NLARDL approach (Shin et al., 2014).FindingsThe authors prove that the increase in the unemployment gap has greater disinflationary effects than the RCLC in both the short and the long term; the expansionary phases of the business cycle, which reduce UGap, do not have inflationary effects either in the short or in the long run, but improvements in the labor market do, when RCLC is reduced; raising RCLC appears to have been the companies’ main survival strategy since 2015; and these asymmetries can generate a low unemployment trap with high and growing precariousness, with huge dynamic costs for well-being, economic growth, inequality and poverty.Social implicationsAs labor precariousness grows, the implications are several both in the short and long run. In the short run, the most notorious example of the effects on workers has to do with unstable and insecure situations, that disrupt all their life planning options, and health issues. Bohle et al. (2004) found in the Organization for Economic Cooperation and Development countries that casual employees had less desirable and predictable working hours, greater work–life conflict and more associated health complaints than people with permanent jobs.Originality/valueThe approach includes the labor precariousness variable, which describes a new phenomenon in the labor market. Nowadays, workers are facing a new threat since firms are employing a new labor cost reduction strategy in which they do not lay off workers but rather paying them less, working them more hours, or reducing benefits. The asymmetries between the effects of precarity and unemployment can generate a poverty trap in the long run. This problem is, once again, of great relevance in the context of global high inflation.

Predicting inflation expectations: A habit-based explanation under hedging

One of the main challenges monetary policymakers face is predicting the trajectory of short-term inflation, especially considering the consistently flat Phillips curve observed in recent years. A promising approach to tackling this challenge involves modifying the hybrid New Keynesian Phillips curve (HNKPC) by incorporating a hedging factor. This factor accounts for the efforts risk-averse economic agents make to safeguard their spending decisions against uncertainties arising from inflation. Our study provides evidence that the hedging factor plays a crucial role and is a statistically significant predictor of the upcoming year's inflation rate. Specifically, a one-standard-deviation increase in the hedging factor predicts a positive rise in short-term inflation. Furthermore, we demonstrate that the hedging factor significantly determines the common component found in both well-known survey-based and model-based inflation expectation indicators.

Drivers of inflation in Turkey: a new Keynesian Phillips curve perspective

Drivers of inflation in Turkey: a new Keynesian Phillips curve perspective

Model Specification and Inflation Forecast Uncertainty in the Case of Pakistan

Making a better estimate of Inflation can enable us to make a better guesstimate about its economic repercussions. In modern monetary economics, the standard Phillips Curve model (PCM), the New Keynesian Phillips curve model (NPCM), and the incomplete competition model (ICM) are the alternative econometric models specified to forecast Inflation. The present study intends to identify the appropriate inflation model based on its forecasting performance with its different specifications for Pakistan's Economy. PCM includes the output gap and unemployment rate, NPCM has forward-looking expectations and uses labor income share instead of the output gap, and ICM identifies the importance of incomplete information on labor and product markets and uses some error correction term (ECT) to forecast Inflation. The relevant ECT has overcome the omitted variable bias. ICM is better in visualization forecasting and has lower root mean square error and mean absolute percentage error than other inflation models. In conclusion, the wage-price dynamics model (ICM) offers the best prospect of a successful inflation forecast in the case of Pakistan.

Heterogeneous beliefs and the Phillips curve

Heterogeneous beliefs modify the New Keynesian Phillips curve by introducing a term in the cross-section distribution of expectations. To take that model to the data, we develop a novel functional data approach to estimation and inference that accounts for variation in distributions of expectations. We find that this variation may be summarized using a handful of functional factors, and demonstrate their statistical and economic relevance for inflation dynamics. Our results are among the first to highlight the potential benefits to be gained in empirical work from a rigorous treatment of diverse beliefs in the study of macroeconomic outcomes.

Trend inflation and evolving inflation dynamics: A Bayesian GMM analysis

Inflation dynamics are investigated by estimating a generalized version of the New Keynesian Phillips curve (NKPC) of Galí and Gertler (1999) using Bayesian GMM. US macroeconomic data suggests that the generalized NKPC (GNKPC) performs best in terms of quasi-marginal likelihood among those considered both during and after the Great Inflation period. The estimated GNKPC indicates that when trend inflation fell after the Great Inflation period, the probability of price change decreased and the GNKPC flattened, which is in line with findings by previous studies.

A hybrid NKPC inflation model for the small Island state of Fiji

This study models (consumer price) inflation for an open small island state of Fiji. We introduce, within a hybrid open-economy version of the New Keynesian Phillips Curve (NKPC) model, the effects of development in the stock market, and frequent sources of economic and political uncertainty on inflation. Using monthly data over the period for the period February 1996 to December 2020, we show that a model with expectations of forward- and backward-looking economic agents alone can explain 85% inflation. Other NKPC variables have explanatory power of 10% boost this to 27% relationships in the hybrid NKPC model. Overall, the study implies that inflation expectations of economic agents, if managed effectively, can avoid persistently high inflation rates.