Testing for the New Keynesian Phillips Curve. Additional international evidence

The “New Keynesian” Phillips Curve (NKPC) states that inflation has a purely forward-looking dynamics. In this paper, we test whether the inflation dynamics in European countries can be adequately described by this model. For this purpose, we estimate hybrid Phillips curves, which include both backward- and forward-looking components, for major European countries, the euro area, and the US. Using both GMM and ML estimation procedures, we examine the sensitivity of the estimates to the choice of output gap or real unit labor cost (ULC) as forcing variable and to the number of lags and leads in the inflation dynamics. Then, we provide several specification tests for the models estimated. Our findings can be summarized as follows. First, the forward-lookingness of the inflation dynamics is not altered by the choice of the forcing variable. In contrast, it is strongly affected by the lag and lead structure of inflation. Two specifications emerge: the real ULC specification with a single lag and lead and a large forward-looking component which is relevant in the US and the UK. The output gap specification with three lags and leads and a low degree of forward-lookingness provides a better fit for continental Europe.