The New Keynesian Model and the Long-Run Vertical Phillips Curve: Does It Hold for Germany?

Arbeitspapier

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 cointegration analysis technique. The results point to a structural break in the late 1970s. In the later time period we find for West German 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.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: DIW Discussion Papers ; No. 521

Classification and Topics

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

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Gottschalk, Jan ; Fritsche, Ulrich
• Event: Veröffentlichung
• (who): Deutsches Institut für Wirtschaftsforschung (DIW)
• (where): Berlin
• (when): 2005

Further information

• Handle: http://hdl.handle.net/10419/18372
• Last update: 10.03.2025, 11:41 AM CET