Working Paper: CEPR ID: DP2246
Authors: Jordi Gal; Mark Gertler
Abstract: We develop and estimate a structural model of inflation that allows for a fraction of firms that use a backward looking rule to set prices. The model nests the purely forward looking New Keynesian Phillips curve as a particular case. We use measures of marginal cost as the relevant determinant of inflation, as the theory suggests, instead of an ad-hoc output gap. Real marginal costs are a significant and quantitatively important determinant of inflation. Backward looking price setting, while statistically significant, is not quantitatively important. Thus, we conclude that the New Keynesian Phillips curve provides a good first approximation to the dynamics of inflation.
Keywords: inflation; Phillips curve; real marginal cost
JEL Codes: E31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lagged inflation (E31) | current unit labor costs (J39) |
| real marginal costs (D40) | inflation inertia (E31) |
| real marginal costs (D40) | output gap (E23) |
| real marginal costs (D40) | inflation (E31) |