Monetary Policy Shifts, Indeterminacy and Inflation Dynamics

The New-Keynesian Phillips curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various postwar full-samples. While it is well know that in a New-Keynesian model a weak central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for the estimates of the Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the estimated process of inflation. This persistence however is not an intrinsic feature of the economy; rather it is the result of self full-filling expectations. By neglecting indeterminacy the estimates of the forward- looking term of the Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the UK and US.