Identication of New Keynesian Phillips Curves from a Global Perspective

This paper is concerned with the estimation of New Keynesian Phillips Curves (NKPC) and focusses on two issues: the weak instrument problem and the characterisation of the steady states. It proposes some solutions from a global perspective. Using a global vector autoregressive model (GVAR) steady states are estimated as long-horizon expectations and valid instruments are constructed from the global variables as weighted averages. The proposed estimation strategy is illustrated using estimates of the NKPC for 8 developed industrial countries. The GVAR generates global factors that are valid instruments and help alleviate the weak instrument problem. The steady states also re‡ect global in‡uences and any long-run theoretical relationships that might prevail within and across countries in the global economy. The GVAR measure of the steady state performed better than the HP measure, and the use of foreign instruments substantially increased the precision of the estimates of the output coe¢ cient. Keywords: Steady States, Long Horizon Expectations, Global VAR, identi…cation, New Keynesian Phillips Curve, Trend-Cycle Decomposition. JEL Classi…cation: C32, E17, F37, F42. For Stephane Dees, the views expressed in this paper do not necessarily re‡ect the views of the European Central Bank or the Eurosystem. The other authors are grateful to the European Central Bank for …nancial support. We are also grateful for helpful comments from the Editor, two anonymous referees, Alex Al-Haschimi, Andreas Beyer, Alex Chudik, Huw Dixon, Luca Fanelli, Adrian Pagan and participants at various conferences where earlier versions were presented.