Alternative Sources of the Lag Dynamics of Inflation

New Keynesian Phillips curves are widely used in macroeconomic policy models to simulate the inflation consequences of alternative monetary policies. The purely forward-looking inflation specification is appealing, because it is based on a model of optimal pricing behaviour. However, based on empirical evidence, the standard view is that there is considerable persistence in inflation. Consequently, the purely forward-looking specification is controverisal, because it excludes lagged inflation terms and, contrary to empirical evidence, implies that inflation is not sticky. In fact, prior to the implementation of the forward-looking specifications, Phillips curves in policy models assumed that expectations were purely backwardlooking. Although such specifications lacked the rational-expectations assumptions preferred when analyzing alternative policies, they captured the strong autocorrelations of actual inflation rates.