Arbeitspapier

The New Keynesian Model and the Long-run Vertical Phillips Curve: Does it hold for Germany?

New-Keynesian macroeconomic models typically assume that any long-run trade-off between inflation and unemployment is ruled out. While this appears to be a reasonable characterization of the US economy, it is less clear that the natural rate hypothesis necessarily holds in a European country like Germany where hysteretic effects may invalidate it. Inspired by the framework developed by Farmer (2000) and Beyer and Farmer (2002), we investigate the long-run relationships between the interest rate, unemployment and inflation in West Germany from the early 1960s up to 2004 using a multivariate co-integration analysis technique. The results point to a structural break in the late 1970s. In the later time period we find for west Germany data a strong negative correlation between the trend components of inflation and unemployment. We show that this finding contradicts the natural rate hypothesis, introduce a version of the New Keynesian model which allows for some hysteresis and compare the effectiveness of monetary policy in these two models. In general, a policy rule with an aggressive response to a rise in unemployment performs better in a model with hysteretic characteristics than in a model without.

Language
Englisch

Bibliographic citation
Series: DEP (Socioeconomics) Discussion Papers - Macroeconomics and Finance Series ; No. 1/2006

Classification
Wirtschaft
History of Economic Thought: Macroeconomics
Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Subject
Cointegration
Vector error Correction Model
Unemployment
Phillips Curve
Hysteresis

Event
Geistige Schöpfung
(who)
Fritsche, Ulrich
Gottschalk, Jan
Event
Veröffentlichung
(who)
Hamburg University, Department Economics and Politics
(where)
Hamburg
(when)
2006

Handle
Last update
10.03.2025, 11:42 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Fritsche, Ulrich
  • Gottschalk, Jan
  • Hamburg University, Department Economics and Politics

Time of origin

  • 2006

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