Working Paper Series no. 118: Partial Indexation, Trend Inflation, and the Hybrid Phillips Curve

Abstract

This paper proposes a full description of the Calvo price-setting model based on partial prices indexation and studies the interaction between partial indexation and trend inflation. We show that using a hybrid version of the Phillips curve partly decreases the risks of overestimate due to the omission of trend inflation. We also provide new evidence on the fit of the hybrid Phillips curve for the Euro area and the United States 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 percent of the probability to not change the price, for reasonable values of trend inflation.

Jean-Guillaume Sahuc
December 2004

Classification JEL : E31, C22.

Keywords : Phillips curve, inflation inertia, trend inflation, degree of indexation.