Inflation Dynamics and New Keynesian Phillips Curve: A Reassessment for Pakistan

New Keynesian Phillips Curve: A Reassessment for Pakistan

Abstract

This study tests empirical consistency of the NKPC for its standard and
hybrid versions over the period 1972 to 2012. Empirical findings of the
standard NKPC show that both expected inflation and output gap play
important role in explaining inflation behavior in Pakistan. As the standard
NKPC does not generate inflation persistence, so, we tested the hybrid
version of NKPC. The estimates of the hybrid NKPC reveal that although
both the lagged period inflation and expected future inflation are statistically
significant but the coefficient of lagged inflation is quantitatively larger than
that of the expected inflation which means that the price setting behavior is
dominantly backward looking in Pakistan. Furthermore, the output gap is
found to be significantly and positively affecting inflation in the country. The
findings of this study suggest that the NKPC can be used as a benchmark
model for understanding the inflation behaviour in Pakistan.