The Hybrid New Keynesian Phillips Curve with Multiple Lags of Inflation

Abstract

In deriving the hybrid new Keynesian Phillips curve (HNKPC) in Galí and Gertler (1999) and Holmberg (2006), it is assumed that backward-looking firms index their prices to the average prices newly set last period plus last period’s inflation rate, resulting in a Phillips curve equation that relates current inflation to a demand variable, expected future inflation, and last period’s inflation. The present study generalizes the derivation of the HNKPC to allow firms to index prices to multiple lags of inflation, resulting in a HNKPC in which current inflation depends on multiple lags of inflation instead of only one lag of inflation, providing theoretical justification for empirical specifications of the HNKPC that include more than one lag of inflation.