THE PHILLIPS CURVE AND A MICRO-FOUNDATION OF TREND INFLATION
Abstract
The hybrid New Keynesian Phillips curve has been criticized for lacking a micro-foundation. In this paper, an alternative purely forward-looking model of the Phillips curve is constructed on the basis of a micro-foundation of trend inflation. In addition, another source of output gaps other than frictions―a Nash equilibrium of a Pareto inefficient path―is considered. The model indicates that the role of frictions has been overestimated and that frictions are less important than previously have been thought. The conventional monetary policy of utilizing frictions cannot necessarily stabilize inflation. In contrast, the monetary policy of controlling the government’s preference is very effective. A problem is that the effects of both types of monetary policy are not distinguishable.
References
[1] Alesina, A. (1988). Macroeconomics and Politics, NBER Macroeconomics Annual. Cambridge, MA: Cambridge University Press: 13-52.
[2] Alesina, A. and Cukierman, A. (1990). The Politics of Ambiguity, The Quarterly Journal of Economics, 105(4): 829–850.
[3] Alesina, A. and Drazen, A. (1991). Why Are Stabilizations Delayed? International Economic Review, 81(5): 1170–88.
[4] Ascari, G. (2004). Staggered Prices and Trend Inflation: Some Nuisances, Review of Economic Dynamics, 7(3): 642-667.
[5] Bakhshi, Hasan, Pablo Burriel-Llombart, Hashmat Khan and Barbara Rudolf. (2003). Endogenous Price Stickiness, Trend Inflation, and the New Keynesian Phillips Curve, Bank of England Working Paper, 191.
[6] Barro, R.J. and Gordon, D. B. (1983). A Positive Theory of Monetary Policy in a Natural Rate Model, The Journal of Political Economy, 91(4): 589–610.
[7] Becker, G.S. and Mulligan, C. (1997). The Endogenous Determination of Time Preference, Quarterly Journal of Economics, 112(3): 729–758.
[8] Blinder, A.S. (1998). Central Banking in Theory and Practice. Cambridge: The MIT Press.
[9] Böhm-Bawerk, E. von. (1889). Capital and Interest. Reprinted by Libertarian Press, South Holland, IL, 1970.
[10] Brennan, G. and Buchanan, J. M. (1980). The Power to Tax: Analytical Foundations of a Fiscal Constitution. Cambridge MA: Cambridge University Press.
[11] Christiano, L. and Fitzgerald, T.J. (2000). Understanding the Fiscal Theory of the Price Level, Federal Reserve Bank of Cleveland Economic Review Q II: 2-38.
[12] Clarida, R., Gali, J. and Gertler, M. (1999). The Science of Monetary Policy: A New Keynesian Perspective, Journal of Economic Literature, 37: 1661—1707.
[13] Cochrane, J.H. (1998a). A Frictionless View of US Inflation, NBER Macroeconomics Annual. Cambridge, MA: MIT Press: 323–384.
[14] Cochrane, J.H. (1998b). Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level, NBER Working Paper, 6771.
[15] Cochrane, J.H. (2005). Money as Stock: Price Level Determination with No Money Demand, Journal of Monetary Economics, 52(3): 501–528.
[16] Cogley, T. and Sbordone, A. M. (2005). A Search for a Structural Phillips Curve, Federal Reserve Bank of New York, Staff Reports, 203.
[17] Cogley, T. and Sbordone, A. M. (2006). Trend Inflation and Inflation Persistence in the New Keynesian Phillips Curve, Federal Reserve Bank of New York, Staff Reports, 270.
[18] Downs, A. (1957). An Economic Theory of Democracy. New York: Harper.
[19] Edwards, J. and Keen, M. (1996). Tax Competition and Leviathan, European Economic Review, 40(1): 113–134.
[20] Fisher, I. (1930). The Theory of Interest. New York: Macmillan.
[21] Fuhrer, J. (2006). Intrinsic and Inherited Inflation Persistence, International Journal of Central Banking, 2(3): 49-86.
[22] Fuhrer, J. and Moore, G. (1995). Inflation Persistence, Quarterly Journal of Economics, 110(1): 127-159.
[23] Galí, J. and Gertler, M. (1999). Inflation Dynamics: A Structural Econometric Analysis, Journal of Monetary Economics, 44(2): 195–222.
[24] Galí, J., Gertler, M. and López-Salido, D. (2005). Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve, Journal of Monetary Economics, 52(6): 1107-1118.
[25] Harashima, T. (2004a). A More Realistic Endogenous Time Preference Model and the Slump in Japan, EconWPA Working Papers, ewp-mac0402015.
[26] Harashima, T. (2004b). The Ultimate Source of Inflation: A Microfoundation of the Fiscal Theory of the Price Level, EconWPA Working Papers.
[27] Harashima, T. (2007). Hyperinflation, Disinflation, Deflation, etc.: A Unified and Micro-founded Explanation for Inflation, MPRA (The Munich Personal RePEc Archive) Paper, 3836.
[28] Harashima, T. (2008a). The Cause of the Great Inflation: Interactions between Government and Monetary Policymakers, The Journal of World Economic Review 3(1): 69-89.
[29] Harashima, T. (2008b). A Microfounded Mechanism of Observed Substantial Inflation Persistence, MPRA (The Munich Personal RePEc Archive) Paper, 10668.
[30] Harashima, T. (2012). A Mechanism of Cyclical Volatility in the Vacancy-Unemployment Ratio: What Is the Source of Rigidity? (The Munich Personal RePEc Archive) Paper, 36895.
[31] Harashima, T. (2013a). The Optimal Quantity of Money Consistent with Positive Nominal Interest Rates, Journal of Kanazawa Seiryo University 46(2): 27-36 (in Japanese).
[32] Harashima, T. (2013b). The Economics of Fiscal Deficits (Zaisei Akaji No Keizaigaku). Nagoya, Japan: Buitsu-Soryushon (in Japanese).
[33] Harashima, T. (2013c). Escaping a Liquidity Trap: Keynes’ Prescription Is Right But His Reasoning Is Wrong, (The Munich Personal RePEc Archive) Paper, 48115.
[34] Hornstein, A. (2007). Evolving Inflation Dynamics and the New Keynesian Phillips Curve, Federal Reserve Bank of Richmond Economic Quarterly, Fall 2007: 317-339.
[35] Kydland, F.E. and Prescott, E.C. (1977). Rules Rather than Discretion: The Inconsistency of Optimal Plans, Journal of Political Economy, 85(3): 473–491.
[36] Lawrance, E.C. (1991). Poverty and the Rate of Time Preference: Evidence from Panel Data, Journal of Political Economy, 99(1): 54–77.
[37] Leeper, E. (1991). Equilibria under Active and Passive Monetary and Fiscal Policies, Journal of Monetary Economics, 27: 129–147.
[38] Mankiw, G. (2001). The Inexorable and Mysterious Tradeoff between Inflation and Unemployment, The Economic Journal, 111(471): C45-C61.
[39] Morris, S. and Hyun, S.S. (2001). Rethinking Multiple Equilibria in Macroeconomic Modeling, NBER Macroeconomics Annual. Cambridge, MA: Cambridge University Press: 139–182.
[40] Parkin, M. (1988). A Method for Determining Whether Parameters in Aggregative Models Are Structural, Carnegie-Rochester Conference Series on Public Policy 29(1): 215–252.
[41] Samuelson, P. (1937). A Note on Measurement of Utility,” Review of Economic Studies, 4(2): 155–161.
[42] Sbordone, A.M. (2007). Inflation Persistence: Alternative Interpretations and Policy Implications, Journal of Monetary Economics, 54: 1311–1339.
[43] Sidrauski, M. (1967). Rational Choice and Patterns of Growth in a Monetary Economy, American Economic Review, 57(2): 387–393.
[44] Sims, C.A. (1994). A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy, Economic Theory, 4: 381–399.
[45] Sims, C.A. (1998). Econometric Implications of the Government Budget Constraint, Journal of Econometrics, 83: 9–19.
[46] Sims, C.A. (2001). Fiscal Consequence for Mexico Adopting the Dollar, Journal of Money, Credit and Banking, 23: 597–625.
[47] Stock, J.H. and Watson, M.W. (2006). Why Has U.S. Inflation Become Harder to Forecast?” NBER Working Paper, 12324.
[48] Svensson, L.E.O. and Woodford, M. (2003). Implementing Optimal Policy through Inflation-Forecast Targeting, NBER Working Paper, 9747.
[49] Tabellini, G. and Alesina, A. (1990). Voting on the Budget Deficit, American Economic Review, 80(1): 37–49.
[50] Woodford, M. (1995). Price Level Determinacy without Control of a Monetary Aggregate, Carnegie-Rochester Conference Series on Public Policy, 43: 1–46.
[51] Woodford, M. (2001). Fiscal Requirements for Price Stability, Journal of Money, Credit and Banking, 33: 669-728.
[52] Woodford, M. (2007). Interpreting Inflation Persistence: Comments on the Conference on Quantitative Evidence on Price Determination, Journal of Money, Credit and Banking, 39(s1): 203-210.
[2] Alesina, A. and Cukierman, A. (1990). The Politics of Ambiguity, The Quarterly Journal of Economics, 105(4): 829–850.
[3] Alesina, A. and Drazen, A. (1991). Why Are Stabilizations Delayed? International Economic Review, 81(5): 1170–88.
[4] Ascari, G. (2004). Staggered Prices and Trend Inflation: Some Nuisances, Review of Economic Dynamics, 7(3): 642-667.
[5] Bakhshi, Hasan, Pablo Burriel-Llombart, Hashmat Khan and Barbara Rudolf. (2003). Endogenous Price Stickiness, Trend Inflation, and the New Keynesian Phillips Curve, Bank of England Working Paper, 191.
[6] Barro, R.J. and Gordon, D. B. (1983). A Positive Theory of Monetary Policy in a Natural Rate Model, The Journal of Political Economy, 91(4): 589–610.
[7] Becker, G.S. and Mulligan, C. (1997). The Endogenous Determination of Time Preference, Quarterly Journal of Economics, 112(3): 729–758.
[8] Blinder, A.S. (1998). Central Banking in Theory and Practice. Cambridge: The MIT Press.
[9] Böhm-Bawerk, E. von. (1889). Capital and Interest. Reprinted by Libertarian Press, South Holland, IL, 1970.
[10] Brennan, G. and Buchanan, J. M. (1980). The Power to Tax: Analytical Foundations of a Fiscal Constitution. Cambridge MA: Cambridge University Press.
[11] Christiano, L. and Fitzgerald, T.J. (2000). Understanding the Fiscal Theory of the Price Level, Federal Reserve Bank of Cleveland Economic Review Q II: 2-38.
[12] Clarida, R., Gali, J. and Gertler, M. (1999). The Science of Monetary Policy: A New Keynesian Perspective, Journal of Economic Literature, 37: 1661—1707.
[13] Cochrane, J.H. (1998a). A Frictionless View of US Inflation, NBER Macroeconomics Annual. Cambridge, MA: MIT Press: 323–384.
[14] Cochrane, J.H. (1998b). Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level, NBER Working Paper, 6771.
[15] Cochrane, J.H. (2005). Money as Stock: Price Level Determination with No Money Demand, Journal of Monetary Economics, 52(3): 501–528.
[16] Cogley, T. and Sbordone, A. M. (2005). A Search for a Structural Phillips Curve, Federal Reserve Bank of New York, Staff Reports, 203.
[17] Cogley, T. and Sbordone, A. M. (2006). Trend Inflation and Inflation Persistence in the New Keynesian Phillips Curve, Federal Reserve Bank of New York, Staff Reports, 270.
[18] Downs, A. (1957). An Economic Theory of Democracy. New York: Harper.
[19] Edwards, J. and Keen, M. (1996). Tax Competition and Leviathan, European Economic Review, 40(1): 113–134.
[20] Fisher, I. (1930). The Theory of Interest. New York: Macmillan.
[21] Fuhrer, J. (2006). Intrinsic and Inherited Inflation Persistence, International Journal of Central Banking, 2(3): 49-86.
[22] Fuhrer, J. and Moore, G. (1995). Inflation Persistence, Quarterly Journal of Economics, 110(1): 127-159.
[23] Galí, J. and Gertler, M. (1999). Inflation Dynamics: A Structural Econometric Analysis, Journal of Monetary Economics, 44(2): 195–222.
[24] Galí, J., Gertler, M. and López-Salido, D. (2005). Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve, Journal of Monetary Economics, 52(6): 1107-1118.
[25] Harashima, T. (2004a). A More Realistic Endogenous Time Preference Model and the Slump in Japan, EconWPA Working Papers, ewp-mac0402015.
[26] Harashima, T. (2004b). The Ultimate Source of Inflation: A Microfoundation of the Fiscal Theory of the Price Level, EconWPA Working Papers.
[27] Harashima, T. (2007). Hyperinflation, Disinflation, Deflation, etc.: A Unified and Micro-founded Explanation for Inflation, MPRA (The Munich Personal RePEc Archive) Paper, 3836.
[28] Harashima, T. (2008a). The Cause of the Great Inflation: Interactions between Government and Monetary Policymakers, The Journal of World Economic Review 3(1): 69-89.
[29] Harashima, T. (2008b). A Microfounded Mechanism of Observed Substantial Inflation Persistence, MPRA (The Munich Personal RePEc Archive) Paper, 10668.
[30] Harashima, T. (2012). A Mechanism of Cyclical Volatility in the Vacancy-Unemployment Ratio: What Is the Source of Rigidity? (The Munich Personal RePEc Archive) Paper, 36895.
[31] Harashima, T. (2013a). The Optimal Quantity of Money Consistent with Positive Nominal Interest Rates, Journal of Kanazawa Seiryo University 46(2): 27-36 (in Japanese).
[32] Harashima, T. (2013b). The Economics of Fiscal Deficits (Zaisei Akaji No Keizaigaku). Nagoya, Japan: Buitsu-Soryushon (in Japanese).
[33] Harashima, T. (2013c). Escaping a Liquidity Trap: Keynes’ Prescription Is Right But His Reasoning Is Wrong, (The Munich Personal RePEc Archive) Paper, 48115.
[34] Hornstein, A. (2007). Evolving Inflation Dynamics and the New Keynesian Phillips Curve, Federal Reserve Bank of Richmond Economic Quarterly, Fall 2007: 317-339.
[35] Kydland, F.E. and Prescott, E.C. (1977). Rules Rather than Discretion: The Inconsistency of Optimal Plans, Journal of Political Economy, 85(3): 473–491.
[36] Lawrance, E.C. (1991). Poverty and the Rate of Time Preference: Evidence from Panel Data, Journal of Political Economy, 99(1): 54–77.
[37] Leeper, E. (1991). Equilibria under Active and Passive Monetary and Fiscal Policies, Journal of Monetary Economics, 27: 129–147.
[38] Mankiw, G. (2001). The Inexorable and Mysterious Tradeoff between Inflation and Unemployment, The Economic Journal, 111(471): C45-C61.
[39] Morris, S. and Hyun, S.S. (2001). Rethinking Multiple Equilibria in Macroeconomic Modeling, NBER Macroeconomics Annual. Cambridge, MA: Cambridge University Press: 139–182.
[40] Parkin, M. (1988). A Method for Determining Whether Parameters in Aggregative Models Are Structural, Carnegie-Rochester Conference Series on Public Policy 29(1): 215–252.
[41] Samuelson, P. (1937). A Note on Measurement of Utility,” Review of Economic Studies, 4(2): 155–161.
[42] Sbordone, A.M. (2007). Inflation Persistence: Alternative Interpretations and Policy Implications, Journal of Monetary Economics, 54: 1311–1339.
[43] Sidrauski, M. (1967). Rational Choice and Patterns of Growth in a Monetary Economy, American Economic Review, 57(2): 387–393.
[44] Sims, C.A. (1994). A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy, Economic Theory, 4: 381–399.
[45] Sims, C.A. (1998). Econometric Implications of the Government Budget Constraint, Journal of Econometrics, 83: 9–19.
[46] Sims, C.A. (2001). Fiscal Consequence for Mexico Adopting the Dollar, Journal of Money, Credit and Banking, 23: 597–625.
[47] Stock, J.H. and Watson, M.W. (2006). Why Has U.S. Inflation Become Harder to Forecast?” NBER Working Paper, 12324.
[48] Svensson, L.E.O. and Woodford, M. (2003). Implementing Optimal Policy through Inflation-Forecast Targeting, NBER Working Paper, 9747.
[49] Tabellini, G. and Alesina, A. (1990). Voting on the Budget Deficit, American Economic Review, 80(1): 37–49.
[50] Woodford, M. (1995). Price Level Determinacy without Control of a Monetary Aggregate, Carnegie-Rochester Conference Series on Public Policy, 43: 1–46.
[51] Woodford, M. (2001). Fiscal Requirements for Price Stability, Journal of Money, Credit and Banking, 33: 669-728.
[52] Woodford, M. (2007). Interpreting Inflation Persistence: Comments on the Conference on Quantitative Evidence on Price Determination, Journal of Money, Credit and Banking, 39(s1): 203-210.
Published
2013-12-31
How to Cite
HARASHIMA, Taiji.
THE PHILLIPS CURVE AND A MICRO-FOUNDATION OF TREND INFLATION.
Theoretical and Practical Research in Economic Fields, [S.l.], v. 4, n. 2, p. 151-182, dec. 2013.
ISSN 2068-7710.
Available at: <https://journals.aserspublishing.eu/tpref/article/view/1217>. Date accessed: 27 july 2024.
Section
Articles
Non-Exclusive License under Attribution 4.0 International Public License (CC BY 4.0):
This ‘Article’ is distributed under the terms of the license CC-BY 4.0., which lets others distribute, remix, adapt, and build upon this article, even commercially, as long as they credit this article for the original creation. ASERS Publishing will be acknowledged as the first publisher of the Article and a link to the appropriate bibliographic citation (authors, article title, volume issue, page numbers, DOI, and the link to the Published Article on ASERS Publishing’ Platform) must be maintained.