Estimating the New Keynesian Phillips Curve for the UK: evidence from the inflation-indexed bonds market

Abstract

Abstract:This paper utilizes the information in the inflation-indexed bonds market to estimate the New Keynesian Phillips Curve for the UK using an unobserved component approach. The main advantage of this approach comes from using the Kalman filter to explicitly estimate the unobserved expected inflation from the observed break-even inflation rates -the yield difference between the inflation-indexed bonds and the nominal bonds. Our results show that the expected inflation estimated from the unobserved component model plays a significant role in explaining the inflation dynamics in the UK. The evidence also suggests that the estimated inflation expectations are better able to capture the evolution of actual inflation process as compared to the break-even inflation rate as a proxy for expected inflation.

Anchoring inflation expectations in the face of oil shocks & in the proximity of ZLB: A tale of two targeters

“…Similarly, Fuhrer (2011) reports only a short-run nexus between inflation and inflation expectations in the US. In contrast, Lagoa (2017) and Marfatia (2018) report an enduring nexus between inflation and inflation expectations in Europe. Posen (2011) provides further specifications focused on the UK.…”

“…For the evolution of theory seePhelps (1967) andFriedman (1968) and most recentlyMarfatia (2018).5 One might also note that Bank of Japan, European Central Bank (ECB) and the Riksbank have opted for negative rates(Nasir, 2017).…”

Exchange rate pass-through & management of inflation expectations in a small open inflation targeting economy

“…However, analysing the data on the Euro Area and the UK, Lagoa (2017) and Marfatia (2018) report a strong nexus. In the case of the UK economy, Posen (2011) claims that accounting for inflation expectations (as well anchored) is crucial to understanding and forecasting inflation 6 .…”

“…It is reasonable to suggest that inflation expectations are themselves influenced by the determinants of inflation. The relationship between inflation expectations and inflation has profound significance and there is substantial theoretical and empirical support for this nexus (see Friedman (1968) and Phelps (1967) or lately Marfatia (2018) and Nasir et al (2020). In this regard, it is supposed that I.T.…”

Inflation targeting & implications of oil shocks for inflation expectations in oil-importing and exporting economies: Evidence from three Nordic Kingdoms

“…In terms of its determinants, theoretical explanation and empirical evidence suggest that the inflation dynamics are shaped by the aggregate demand (output gaps), outlook of labour market (slack or spare capacity) supply and cost shocks, exchange rate movement, degree of fiscal discipline, past inflation and inflation expectations (discussion in next section). Among these factors, inflation expectation is perceived to be one of the most crucial factors and a considerable amount of theoretical and empirical studies have voiced this argument, for example, Friedman (1968) and Phelps (1967) to most recently Marfatia (2018). In this regard, inflation targeting plays or is intended to play the most crucial role, particularly in terms of anchoring and mooring the inflation expectations and increasing the credibility of monetary authorities Morgan (2009); Nasir et al (2020a,b) .…”