The Phillips curve under state-dependent pricing

Hasan Bakhshi, Hashmat Khan and Barbara Rudolf



JEL classification
E44, E51, E52

state-dependent pricing, inflation dynamics, Phillips curve


This paper is related to a large recent literature studying the Phillips curve in sticky-price equilibrium models. It differs in allowing for the degree of price stickiness to be determined endogenously. A closed-form solution for short-term inflation is derived from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing originallydev eloped byDotsey , King and Wolman. This generalised Phillips curve encompasses the New Keynesian Phillips curve (NKPC) based on Calvo-type price-setting as a special case. It describes current inflation as a function of lagged inflation, expected future inflation, and current and expected future real marginal costs. The paper demonstrates that inflation dynamics generated bythe model for a broad class of time and state-dependent price-setting behaviours are well approximated bythe popular hybrid NKPC (with one lag of inflation) in a low-inflation environment. This provides an explanation of whythe hybrid NKPC performs well in describing inflation dynamics across industrial countries. It implies, however, that the reduced-form coefficients of the hybrid NKPC maynot have a structural interpretation.