New keynesian phillips curve
The New Keynesian Phillips Curve (NKPC) is a theoretical framework in macroeconomics that describes the relationship between inflation and economic activity. It is a modern version of the Phillips Curve, which was first proposed by Alban William Phillips in 1958.
The traditional Phillips Curve, which was widely used in the 1960s and 1970s, posited a negative relationship between unemployment and inflation. According to this curve, as unemployment falls, inflation rises, and vice versa. However, the traditional Phillips Curve was later found to be unstable and did not accurately predict inflationary pressures.
The New Keynesian Phillips Curve, on the other hand, is a more nuanced and dynamic framework that takes into account the role of expectations, sticky prices, and monetary policy. It is based on the idea that firms set prices in a way that takes into account their expectations of future inflation, as well as the current state of the economy.
The NKPC is typically represented by the following equation:
πt = πt-1 + β(Eπt+1 - πt-1) + γ(yt - yt*)
where:
- πt is the inflation rate at time t
- πt-1 is the inflation rate at time t-1
- Eπt+1 is the expected inflation rate at time t+1
- β is the coefficient that measures the importance of expected inflation in determining current inflation
- γ is the coefficient that measures the importance of the output gap (yt - yt*) in determining inflation
- yt is the actual output at time t
- yt* is the natural output level at time t
The NKPC suggests that inflation is determined by a combination of three factors:
- The lagged inflation rate (πt-1): This reflects the persistence of inflationary pressures.
- The expected inflation rate (Eπt+1): This reflects the role of expectations in shaping inflationary pressures.
- The output gap (yt - yt*): This reflects the impact of economic activity on inflation.
The NKPC has several key features that distinguish it from the traditional Phillips Curve:
- Expectations matter: The NKPC takes into account the role of expectations in shaping inflationary pressures.
- Sticky prices: The NKPC assumes that prices are sticky, meaning that firms do not adjust their prices immediately in response to changes in economic conditions.
- Monetary policy: The NKPC recognizes the role of monetary policy in shaping inflationary pressures.
The NKPC has been widely used in macroeconomic modeling and policy analysis, and has been found to be a more accurate and robust framework for understanding inflationary pressures than the traditional Phillips Curve.