Abstract: Is the observed correlation between current and lagged inflation
a function of backward-looking inflation expectations, or do the
lags in inflation regressions merely proxy for rational
forward-looking
expectations, as in the new-Keynesian Phillips curve? Recent
research
has attempted to answer this question by using instrumental
variables
techniques to estimate "hybrid" specifications for inflation that
allow
for effects of lagged and future inflation. We show that these
tests
of forward-looking behavior have very low power against
alternative,
but non-nested, backward-looking specifications, and demonstrate
that
results previously interpreted as evidence for the new-Keynesian
model
are also consistent with a backward-looking Phillips curve. We
develop
alternative, more powerful tests, which find a very limited role
for
forward-looking expectations.
Keywords: Inflation, Phillips curve
Full paper (270 KB PDF)
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Last update: July 24, 2001
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