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.