DP2246 Inflation Dynamics: A Structural Economic Analysis

Author(s): Jordi Galí, Mark Gertler
Publication Date: September 1999
Keyword(s): Inflation, Phillips Curve, Real Marginal Cost
JEL(s): E31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2246

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.