A NEW STRUCTURAL ANALYSIS OF INFLATION AND ECONOMIC ACTIVITY

Jun Gao; Sheng Zhu

doi:10.20472/ES.2019.8.1.003

Authors

Jun Gao University College Cork, Ireland, Ireland Author
Sheng Zhu University College Cork, Ireland, Ireland Author

DOI:

https://doi.org/10.20472/ES.2019.8.1.003

Keywords:

Phillips curve, IS curve, Expectations, Time-varying parameter regression

Abstract

We theoretically investigate the role of expectations in modeling economic activity and the evolution of inflation rates. In our study, the New Keynesian Phillips-IS model is extended by introducing two types of firms, with a fraction of firms using “limited” information to form their expectations. The remaining firms, referred to as forward-looking, use all available information to set prices and make production decisions. We then use UK data to examine the robustness of this extension. To estimate the augmented model, we employ Uhlig’s (2005) prior restrictions and the time-varying parameter regression approach of Nakajima (2011a). The results suggest that the expectations of each type of firm play an important role in explaining inflation and real economic growth in the UK.

Data:
Received: 6 Apr 2019
Revised: 20 May 2019
Accepted: 6 Jun 2019
Published: 20 Jun 2019