Testing the New Keynesian Phillips Curve Through Vector Autoregressive Models: Results from the Euro Area*
| Date | 01 February 2008 |
| DOI | http://doi.org/10.1111/j.1468-0084.2007.00490.x |
| Published date | 01 February 2008 |
| Author | Luca Fanelli |
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OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 70, 1 (2008) 0305-9049
doi: 10.1111/j.1468-0084.2007.00490.x
Testing the New Keynesian Phillips Curve
Through Vector Autoregressive Models:
Results from the Euro Area*
Luca Fanelli
Department of Statistical Sciences, University of Bologna, Bologna, Italy
(e-mail: luca.fanelli@unibo.it)
Abstract
This paper addresses the issue of testing the ‘hybrid’ New Keynesian Phillips curve
(NKPC) through vector autoregressive (VAR) systems and likelihood methods, giv-
ing special emphasis to the case where the variables are non-stationary. The idea is to
use a VAR for both the inflation rate and the explanatory variable(s) to approximate
the dynamics of the system and derive testable restrictions. Attention is focused on
the ‘inexact’ formulation of the NKPC. Empirical results over the period 1971–98
show that the NKPC is far from providing a ‘good first approximation’ of inflation
dynamics in the Euro area.
I. Introduction
The Phillips curve plays a central role in our understanding of business cycles and the
management of monetary policy. Several of the New Keynesian models of inflation
dynamics, including the models of staggered contracts of Taylor (1979) and Calvo
(1983), and the quadratic price adjustment cost model of Rothemberg (1982), have a
common formulation which is similar to the expectations-augmented Phillips curve
of Friedman and Phelps (Roberts, 1995). The empirical literature on the so-called
*I wish to thank Christopher Bowdler, Søren Johansen, David Hendry, Keshab Bhattarai, Massimo
Franchi and three anonymous referees for helpful comments and suggestions on earlier versions of the
paper. I am responsible for all errors. Paper presented at the following conferences: ‘First Italian Congress
of Econometrics and Empirical Economics’, Venice, 24–25 January 2005; ‘The Cointegrated VAR Model:
Methods and Applications’, Copenhagen, 18–20 June 2006; ‘61st European Meeting of the Econometric
Society’, Vienna, 24–28 August 2006. Partial financial support from Italian MIUR grants ex-60% is
gratefully acknowledged.
JEL Classification numbers: C32, C52, E31, E32.
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