American Economic Review: Vol. 96 No. 1 (March 2006)
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Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?
Rudd, Jeremy, and Karl Whelan. 2006. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?" American Economic Review, 96(1): 303-320.
The canonical inflation specification in sticky-price rational expectations models (the new-Keynesian Phillips curve) is often criticized for failing to account for the dependence of inflation on its own lags. In response, many studies employ a "hybrid" specification in which inflation depends on its lagged and expected future values, together with a driving variable such as the output gap. We consider some simple tests of the hybrid model that are derived from its closed form. We find that the hybrid model describes inflation dynamics poorly, and find little empirical evidence for the type of rational, forward-looking behavior that the model implies.
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