Working Paper: CEPR ID: DP17875
Authors: Marcus Hagedorn
Abstract: I show that state-dependent menu cost pricing models give rise to a nominal demand-augmented Phillips curve (NDPC), which adds nominal demand as a second determinant to a standard New Keynesian Phillips curves (NKPC). According to the NDPC, inflation increases if either real marginal costs (gaps) increase [moving along the NKPC] or if nominal demand increases [shifting the NKPC]. A large increase in inflation can thus be consistent with negligible movements in the unemployment rate if the nominal demand impulse is sufficiently strong to induce a large shift of the Phillips curve. From an empirical NKPC perspective, nominal demand maps into endogenous cost-push shocks, but does not imply a non-linear Phillips curve.I estimate the NDPC using cross-sectional data for U.S. states. Consistent with the theory, my estimates confirm that both nominal demand and marginal costs are significant determinants of inflation. In contrast to a large body of time series literature, the dependence of inflation on its past values is small and insignificant.
Keywords: Incomplete Markets; Phillips Curve; Inflation
JEL Codes: E30; E31; E43; E52; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Nominal Demand (D12) | Inflation (E31) |
| Real Marginal Costs (D40) | Inflation (E31) |
| Nominal Demand (D12) | Phillips Curve Shift (E31) |
| Past Inflation (E31) | Nominal Demand (D12) |