Hostname: page-component-7b7567c8c-mnklg Total loading time: 0 Render date: 2026-11-12T20:11:34.949Z Has data issue: false hasContentIssue false
  • English
  • Français

INFLATION IN THE G7: MIND THE GAP(S)?

Published online by Cambridge University Press:  19 December 2013

James Morley,
Jeremy Piger and
Robert Rasche
James Morley
Affiliation:
University of New South Wales
Jeremy Piger*
Affiliation:
University of Oregon
Robert Rasche
Affiliation:
Michigan State University
*
Address correspondence to: Jeremy Piger, Department of Economics, 1285 University of Oregon, Eugene, OR 97403, USA; e-mail: jpiger@uoregon.edu.
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the 'Save PDF' action button.

We investigate the importance of trend inflation and the real-activity gap in explaining inflation in G7 countries since 1960. Our analysis is based on a bivariate unobserved components model of inflation and unemployment in which inflation is decomposed into a stochastic trend and a transitory component. As in recent implementations of the New Keynesian Phillips Curve, it is the transitory component of inflation, or “inflation gap,” that is driven by the real-activity gap, which we measure as the deviation of unemployment from its natural rate. We find that both trend inflation and the inflation gap have been consistent and substantial determinants of inflation at business cycle horizons for all G7 countries since 1960. Also, the real-activity gap explains a large fraction of the variation in the inflation gap for each country. These results provide empirical support for the New Keynesian Phillips Curve augmented with trend inflation.

Keywords

Inflation PersistenceNatural RateNew Keynesian Phillips CurveTrend Inflation

References

REFERENCES

Barnett, A., Groen, J.J.J., and Mumtaz, H. (2010) Time-Varying Inflation Expectations and Economic Fluctuations in the United Kingdom: A Structural VAR Analysis. Bank of England working paper 392.CrossRefGoogle Scholar
Basistha, A. and Nelson, C. (2007) New measures of the output gap based on the forward-looking New Keynesian Phillips Curve. Journal of Monetary Economics 54, 498–511.CrossRefGoogle Scholar
Bernanke, B. (2007) Inflation Expectations and Inflation Forecasting. Speech presented at the Monetary Economics Workshop of the National Bureau of Economic Research Summer Institute, Cambridge, MA.Google Scholar
Beveridge, S. and Nelson, C.R. (1981) A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the business cycle. Journal of Monetary Economics 7, 151–174.CrossRefGoogle Scholar
Brock, W.A., Durlauf, S.N., and West, K.D. (2003) Policy evaluation in uncertain economic environments. Brookings Papers on Economic Activity 1, 235–301.CrossRefGoogle Scholar
Bryan, M.F. and Cecchetti, S.G. (1994) Measuring core inflation. In Mankiw, N.G. (ed.), Monetary Policy. Chicago: Chicago University Press.Google Scholar
Carter, C.K. and Kohn, R. (1994) On Gibbs sampling for state space models. Biometrika 81, 541–553.CrossRefGoogle Scholar
Cecchetti, S.G., Hooper, P., Kasman, B.C., Schoenholtz, K.L., and Watson, M.W. (2007) Understanding the evolving inflation process. In U.S. Monetary Policy Forum Report 1, Rosenberg Institute for Global Finance, Brandeis International Business School and Initiative on Global Financial Markets, University of Chicago Graduate School of Business.Google Scholar
Clark, T.E. and Davig, T. (2008) An Empirical Assessment of the Relationships among Inflation and Short- and Long-Term Expectations. Federal Reserve Bank of Kansas City Research working paper 08-05.Google Scholar
Cogley, T., Primiceri, G.E., and Sargent, T.J. (2010) Inflation-gap persistence in the U.S. American Economic Journal: Macroeconomics 2, 43–69.Google Scholar
Cogley, T. and Sbordone, A.M. (2008) Trend inflation, indexation, and inflation persistence in the New Keynesian Phillips Curve. American Economic Review 98, 2101–2126.CrossRefGoogle Scholar
Doppelhofer, G., Miller, R., and Sala-i-Martin, X. (2004) Determinants of long-term growth: A Bayesian averaging of classical estimates (BACE) approach. American Economic Review 94, 813–835.Google Scholar
Estrella, A. and Fuhrer, J.C. (2002) Dynamic inconsistencies: Counterfactual implications of a class of rational-expectation models. American Economic Review 92, 1013–1028.CrossRefGoogle Scholar
Friedman, M. (1977) Nobel lecture: Inflation and unemployment. Journal of Political Economy 85, 451–472.CrossRefGoogle Scholar
Fuhrer, J.C. (1997) The (un)importance of forward looking behavior in price specifications. Journal of Money, Credit and Banking 29, 338–350.CrossRefGoogle Scholar
Fuhrer, J.C. and Moore, G. (1995) Inflation persistence. Quarterly Journal of Economics 110, 127–159.CrossRefGoogle Scholar
Gali, J. and Gertler, M. (1999) Inflation dynamics: A structural econometric analysis. Journal of Monetary Economics 44, 195–222.CrossRefGoogle Scholar
Gali, J., Gertler, M., and Lopez-Salido, D. (2001) European inflation dynamics. European Economic Review 45, 1237–1270.CrossRefGoogle Scholar
Gerlach, S. and Smets, F. (1999) Output gaps and monetary policy in the EMU area. European Economic Review 43, 801–812.CrossRefGoogle Scholar
Goodfriend, M. and King, R.G. (2012) The great inflation drift. In The Great Inflation: The Rebirth of Modern Central Banking, pp. 181–209. Cambridge, MA: National Bureau of Economic Research.Google Scholar
Gordon, R.J. (1982) Inflation, flexible exchange rates and the natural rate of unemployment. In Baily, M.N. (ed.), Workers, Jobs and Inflation, pp. 89–158. Washington, DC: Brookings Institution.Google Scholar
Gordon, R.J. (1997) The time-varying NAIRU and its implications for economic policy. Journal of Economic Perspectives 11, 11–32.CrossRefGoogle Scholar
Gordon, R.J. (1998) Foundations of the Goldilocks economy: Supply shocks and the time varying NAIRU. Brookings Papers on Economic Activity 2, 297–333.CrossRefGoogle Scholar
Harvey, A.C. (2008) Modeling the Phillips Curve with Unobserved Components. Cambridge Working Papers in Economics 0805.Google Scholar
Kang, K.H., Kim, C.-J., and Morley, J. (2010) Changes in U.S. inflation persistence. Studies in Nonlinear Dynamics and Econometrics 13.Google Scholar
Kiley, M.T. (2008) Monetary Policy Actions and Long-Run Inflation Expectations. Federal Reserve Finance and Economics Discussion Series working paper 2008-03.CrossRefGoogle Scholar
Kim, C.-J., Manopimoke, P., and Nelson, C.R. (in press) Trend inflation and the nature of structural breaks in the New Keynesian Phillips Curve. Journal of Money, Credit and Banking.Google Scholar
Koop, G. (2003) Bayesian Econometrics. New York: Wiley.Google Scholar
Kuttner, K.N. (1994) Estimating potential output as a latent variable. Journal of Business and Economic Statistics 12, 361–368.Google Scholar
Laubach, T. (2001) Measuring the NAIRU: Evidence from seven economies. Review of Economics and Statistics 83, 218–231.CrossRefGoogle Scholar
Lee, J. and Nelson, C.R. (2007) Expectation horizon and the Phillips Curve: The solution to an empirical puzzle. Journal of Applied Econometrics 22, 161–178.CrossRefGoogle Scholar
Morley, J.C., Nelson, C.R., and Zivot, E. (2003) Why are the Beveridge–Nelson and unobserved components decompositions of GDP so different? Review of Economics and Statistics 85, 235–243.CrossRefGoogle Scholar
Okun, A. (1971) The mirage of steady inflation. Brookings Papers on Economic Activity 2, 485–498.CrossRefGoogle Scholar
Orphanides, A. and van Norden, S. (2002) The unreliability of output-gap estimates in real time. Review of Economics and Statistics 84, 569–583.CrossRefGoogle Scholar
Orphanides, A. and van Norden, S. (2005) The reliability of inflation forecasts based on output gap estimates in real time. Journal of Money, Credit and Banking 37, 583–601.CrossRefGoogle Scholar
Piger, J. and Rasche, R.H. (2008) Inflation: Do expectations trump the gap? International Journal of Central Banking 4, 85–116.Google Scholar
Raftery, A. (1995) Bayesian model selection in social research. Sociological Methodology 25, 111–163.CrossRefGoogle Scholar
Roberts, J. (2001) How Well Does the New Keynesian Sticky-Price Model Fit the Data? Federal Reserve Finance and Economics Discussion Series working paper 2001-13.CrossRefGoogle Scholar
Rudd, J. and Whelan, K. (2005) Does labor's share drive inflation? Journal of Money, Credit and Banking 37, 297–312.CrossRefGoogle Scholar
Smets, F. and Wouters, R. (2003) An estimated dynamic stochastic general equilibrium model of the Euro area. Journal of the European Economic Association 1, 1123–1175.CrossRefGoogle Scholar
Staiger, D., Stock, J., and Watson, M.W. (1997) How precise are estimates of the natural rate of unemployment. In Romer, C. and Romer, D. (eds.), Reducing Inflation: Motivation and Strategy. Chicago: Chicago University Press.Google Scholar
Stock, J.H. and Watson, M.W. (2007) Why has U.S. inflation become harder to forecast? Journal of Money, Credit and Banking 39, 3–33.CrossRefGoogle Scholar
Stock, J.H. and Watson, M.W. (2009) Phillips curve inflation forecasts. In Fuhrer, J., Kodrzycki, Y., Little, J., and Olivei, G. (eds.), Understanding Inflation and the Implications for Monetary Policy, pp. 101–186. Cambridge, MA: MIT Press.CrossRefGoogle Scholar
Stock, J.H. and Watson, M.W. (2010) Modeling Inflation after the Crisis. NBER working paper 16488.CrossRefGoogle Scholar
Wang, J. and Zivot, E. (2000) A Bayesian time series model of multiple structural changes in level, trend, and variance. Journal of Business and Economic Statistics 18, 374–86.Google Scholar