Derivation and Estimation of a New Keynesian Phillips Curve in a Small Open Economy

Abstract

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The Hybrid New Keynesian Phillips Curve with Multiple Lags of Inflation

“…In Holmberg's (2006) derivation of the HNKPC, it is assumed that backwardlooking firms index their prices to the average price newly set last period plus last period's inflation rate. This study extends Holmberg's analysis by assuming that backward-looking firms index their prices to the average price newly set last period plus a weighted average of past inflation rates, allowing for an arbitrarily large number of lags of inflation.…”

“…Following Holmberg (2006), let t p * represent the price (in natural logs) set by firms that are able to adjust their prices in the current period and let θ represent the proportion of firms that are not able to reset their prices. Then, the…”

“…In Galí and Gertler (1999) and Holmberg (2006), when backward-looking firms set prices, they set them equal to the average price set last period by firms that adjusted prices, plus last period's inflation rate. In the present study, when these firms set prices, they set them equal to the average price set last period by firms that adjusted prices plus a weighted average of lagged inflation.…”

“…When wages are indexed to only one lag of inflation, so that 1 1 λ = and 2 3 4 0 λ λ λ λ ∞ = = = = =  , the HNKPC simplifies to the formulation in Galí and Gertler (1999) and Holmberg (2006)…”

“…The former are considered forward-looking firms, and the latter are considered backward-looking firms. Microfoundations for the HNKPC are derived in Holmberg (2006), which presents a derivation of the HNKPC with one lag of inflation.…”