New tests of the new-Keynesian Phillips curve

• Published in: Journal of monetary economics Vol. 52; no. 6; pp. 1167 - 1181
• Main Authors: Rudd, Jeremy, Whelan, Karl
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-09-2005; Elsevier; Elsevier Sequoia S.A
• Series: Journal of Monetary Economics
• Subjects: Econometric models; Economic dynamics; Economic models; Empirical tests; Inflation; Inflation rate; Keynesian theory; Macroeconomics; Model testing; Monetary economics; Neokeynesianism; Phillips curve; Price level; Regression analysis; Studies; E31; Phillips curve; Inflation
• ISSN: 0304-3932; 1873-1295
• DOI: 10.1016/j.jmoneco.2005.08.006

Lagged dependent variables typically play an important role in empirical models of inflation. Do these lags reflect backward-looking inflation expectations, or do they proxy for rational forward-looking expectations, as in the new-Keynesian Phillips curve? Galí and Gertler [1999. Inflation dynamics: a structural econometric analysis. Journal of Monetary Economics 44, 195–222] attempt to answer this question using GMM to estimate specifications incorporating both lagged and future inflation. They report small coefficients on lagged inflation and conclude that the new-Keynesian model provides a good first approximation to inflation dynamics. We show that these tests have low power against alternative backward-looking specifications, and demonstrate that their results are also consistent with a backward-looking Phillips curve. Using an alternative approach, we find that the new-Keynesian pricing model cannot explain the importance of lagged inflation in standard inflation regressions, and find that forward-looking terms play a very limited role in explaining inflation dynamics.