DP5945 | The Phillips Curve Under State-Dependent Pricing

Publication Date

26/11/2006

JEL Code(s)

Keyword(s)

Programme Area(s)

Network(s)

Abstract

This article is related to the large recent literature on Phillips curves in sticky- price equilibrium models. It differs in allowing for the degree of price stickiness to be determined endogenously. A closed-form solution for short-term inflation is derived from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing developed by Dotsey, King and Wolman. This generalized Phillips curve encompasses the New Keynesian Phillips curve (NKPC) based on Calvo-type price-setting as a special case. It describes current inflation as a function of lagged inflation, expected future inflation, current and expected future real marginal costs, and current and past variations in the distribution of price vintages. We find that current inflation depends positively on its own lagged values giving rise to intrinsic persistence as a source of inflation persistence. Also, we find that the state-dependent terms (that is, the variations in the distribution of price vintages) tend to counteract the contribution of lagged inflation to inflation persistence.