Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 197: Derivation and Estimation of a New Keynesian Phillips Curve in a Small Open Economy

Karolina Holmberg ()
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Karolina Holmberg: Monetary Policy Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: In recent years, it has become increasingly common to estimate New Keynesian Phillips curves with a measure of firms' real marginal cost as the real driving variable. It has been argued that this measure is both theoretically and empirically superior to the traditional output gap. In this paper, a marginal-cost based New Keynesian Phillips curve is estimated on Swedish data by means of GMM and Full Information Maximum Likelihood. The results show that with real marginal cost in the structural equation the point estimates generally have the exptected positive sign, which is less frequently the case using the output gap in the Phillips curve equation. This suggests that real marginal cost might be a more adequate real explanatory variable for Swedish inflation than the output gap. However, standard errors in the estimations are large and it is in fact difficult to pin down a statistically significant relationship between either real marginal cost or the output gap and inflation.

Keywords: Inflation; New Keynesian Phillips curve; Real marginal cost; Small Open Economy; GMM; Full Information Maximum Likelihood

JEL-codes: C22; E31; E32

30 pages, May 1, 2006

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