provided by Research Papers in Economics
Estimated Open Economy New Keynesian
Phillips Curves for the G7 *
Campbell Leith Jim Malley
University of Glasgow University of Glasgow
August 5, 2002
Abstract
In this paper we develop an open economy model of firms’ pricing be-
haviour under imperfect competition. This allows us to introduce various
terms of trade effects influencing the firm’s pricing decision, in addition
to labour costs which dominate most closed-economy specifications of the
New Keynesian Phillips (NKPC) curve. Our analysis gives rise to a hy-
brid open economy NKPC which nests existing closed and open economy
specifications adopted in empirical work. We estimate this specification
for the G7 economies and find that the US, UK and Canada typically
enjoy less inertia in price setting than the European G7 economies and
Japan and that these estimates are both plausible and in line with sur-
vey evidence. We also find that the proportion of firms which use simple
backward-looking rules of thumb in price setting is greater when the fre-
quency of price change is smaller. Finally there is evidence of significant
asymmetries in price setting amongst EMU members.
Jel Codes:E3
1 Introduction
The New Keynesian Phillips curve (NKPC), which links current inflation to
expectations of future inflation and a measure of excess demand in the form
of the output gap, has become a mainstay of modern macroeconomics as part
of the ‘New Neo-Classical Synthesis’ (see Goodfriend and King (1997) for a
discussion). However, until recently, this essential building block of modern
macroeconomics has been criticised on empirical grounds (see Mankiw and Reis
(2001), for example), largely because it apparently fails to capture the degree
of inflation inertia many believe to be a feature of the data. Recent work on
the NKPC based on Calvo’s (1983) overlapping contracts framework (see for
*We would like to thank Massimiliano Rigon for comments on an earlier draft of this paper.
Campbell Leith is also grateful to the ESRC (Grant No.L138251050) for financial assistance
in undertaking this research. All errors remain our own.