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THE NEW KEYNESIAN PHILLIPS CURVE AND LAGGED
INFLATION: A CASE OF SPURIOUS CORRELATION?

George Hondroyiannis
Bank of Greece and Harokopio University

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

George S. Tavlas
Bank of Greece

ABSTRACT

The New Keynesian Phillips Curve (NKPC) specifies a relationship between inflation and a forcing variable and the current period’s expectation of future inflation. Most empirical estimates of the NKPC, typically based on Generalized Method of Moments (GMM) estimation, have found a significant role for lagged inflation, producing a “hybrid” NKPC. Using U.S. quarterly data, this paper examines whether the role of lagged inflation in the NKPC might be due to the spurious outcome of specification biases. Like previous investigators, we employ GMM estimation and, like those investigators, we find a significant effect for lagged inflation. We also use time varying coefficient (TVC) estimation, a procedure that allows us to directly confront specification biases and spurious relationships. Using three separate measures of expected inflation, we find strong support for the view that, under TVC estimation, the coefficient on expected inflation is near unity and that the role of lagged inflation in the NKPC is spurious.

Keywords: New Keynesian Phillips curve; time-varying coefficients; spurious relationships.

JEL classification: C51; E31

Acknowledgements: We thank Sophocles Brissimis, Stephen Hall, Nicholas Magginas, Peter von zur Muehlen and Arnold Zellner, for helpful comments. The views expressed are those of the authors and should not be interpreted as those of their respective institutions.

Address for Correspondence:

George Tavlas,
Economic Research Department,
Bank of Greece, 21, E. Venizelos Ave.,
102 50 Athens, Greece
Tel. +30210-320 2370
Fax +30210-320 2432
Email: gtavlas@bankofgreece.gr


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