Monetary Policy Shifts, Indeterminacy and In‡ation Dynamics

The New-Keynesian Phillips curve plays a central role in modern macroeconomic the- ory. 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' cen- tral bank response to in‡ation generates sunspot ‡uctuations, the consequences of pooling observations from dierent monetary policy regimes for the estimates of the structural Phillips curve had not been investigated. Using Montecarlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable per- sistence in the estimated process of in‡ation. This persistence however is not an intrinsic feature of the economy; rather it is endogenous to the policy regime and results from the self full-…lling nature of in‡ation expectations. By neglecting indeterminacy the esti- mates of the forward-looking term of the structural Phillips curve are shown to be biased downward. The implications are in line with the empirical evidence for the U.K and U.S. JEL Classi…cation: E58, E31, E32.