Can rational expectations sticky-price models explain inflation dynamics

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Title: Can rational expectations sticky-price models explain inflation dynamics
Authors: Rudd, Jeremy
Whelan, Karl
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Date: Aug-2003
Abstract: Recent years have seen an important trend in macroeconomic research towards analysing business cycles and stabilization policy in the context of models that incorporate both nominal rigidities and optimising agents with rational expectations. The canonical specification for the behaviour of inflation in these sticky-price rational expectations models (which is known as the new-Keynesian Phillips curve) is often criticized on the grounds that it fails to account for the dependence of inflation on its own lags. In response, many recent studies have employed a “hybrid” sticky-price specification in which inflation depends on a weighted average of lagged and expected future values of itself, in addition to a driving variable such as the output gap. In this paper, we consider some simple tests of the hybrid model that are derived from the model's closed-form solution. Our results suggest that the hybrid model provides a poor description of empirical inflation dynamics, and that there is little evidence of the type of rational forward-looking behavior implied by the model.
Type of material: Technical Report
Publisher: Central Bank of Ireland
Copyright (published version): 2003 Copyright Central Bank of Ireland
Subject LCSH: Inflation (Finance)--Mathematical models
Rational expectations (Economic theory)--United States
Pricing--United States
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Language: en
Status of Item: Not peer reviewed
Appears in Collections:Economics Research Collection

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