Partial indexation and inflation dynamics: what do the data say?

Abstract

New evidence is provided on the fit of the hybrid Phillips curve based on indexation of prices to lagged inflation and trend inflation for the Euro area and the USA over the period 1970–2002. The GMM-West estimates suggest that (i) a full indexation scheme is not data consistent whereas a partial indexation scheme allows a good fit and (ii) forgetting trend inflation induces overestimating by approximately 3–4% of the probability to not change the price, for reasonable values of trend inflation.

Acknowledgements

I would like to thank Eric Jondeau, Hervé Le Bihan, Julien Matheron, Tristan-Pierre Maury, and Ferhat Mihoubi for remarks. This paper represents the views of the author and should not be interpreted as reflecting those of the Banque de France.

Notes

 Under the hypothesis that capital is not reallocated across firms, mc _{t, t+j} is in general different from the average marginal cost at time t + j. This is the reason of the presence of the term (1+ωϵ) in (NPCPI) where ϖ is the output elasticity of real marginal cost for the individual firm. Hat variables indicate log-deviations from steady-state.

In a technical appendix available from the author upon request, all the intermediate steps involved in deriving these results are detailed.

 In the present study, q = 1.

 The study set ε = 10 and ω = 1.25 as is conventionally assumed in the literature (see Woodford, 2003).