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THE NEW KEYNESIAN PHILLIPS CURVE AND INFLATION
EXPECTATIONS: RE-SPECIFICATION AND INTERPRETATION

                                                                 George S. Tavlas
                                                                   Bank of Greece

                                                                P. A. V. B. Swamy
                                                         U.S. Bureau of Labor Statistics

ABSTRACT

A theoretical analysis of the new Keynesian Phillips curve (NKPC) is provided, formulating the conditions under which the NKPC coincides with a real-world relation that is not spurious or misspecified. A time-varying-coefficient (TVC) model, involving only observed variables, is shown to exactly represent the underlying “true” NKPC under certain conditions. In contrast, “hybrid” NKPC models, which add lagged-inflation and supply-shock variables, are shown to be spurious and misspecified. We also show how to empirically implement the NKPC under the assumption that expectations are formed rationally.

Keywords: Time-varying-coefficient model; Inflation-unemployment trade-off; “Objective” probability; Spurious correlation; Rational expectation; Coefficient driver

JEL classification: C51; E31; E42; E50

Acknowledgements
We are grateful to C. D. Aliprantis, Harris Dellas and Arnold Zellner for helpful comments. The views expressed are the authors’ own and do not constitute policy of their respective institutions.

Correspondence:

George S. Tavlas,
Economic Research Department,
Bank of Greece, 21 E. Venizelos Ave.,
102 50 Athens, Greece
Tel.: +30 210 320 2370
Fax: +30 210 320 2432
E-mail: gtavlas@bankofgreece.gr


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