Estimating the New Keynesian Phillips Curve: A Vertical Production Chain Approach


  • This paper was written while I was at the Federal Reserve Bank of Boston and is based on the first chapter of my dissertation submitted to Boston University. I am grateful to Jeff Fuhrer, Simon Gilchrist, and Bob King for guidance and support. I also thank Chris Foote, Kris Gerardi, Eric Giambattista, Fabia Gumbau-Brisá, Adrien Verdelhan, and the participants of the Boston University Macroeconomics Workshop for helpful comments and suggestions.


It has become customary to estimate the New Keynesian Phillips Curve (NKPC) with generalized method of moments using a large instrument set that includes lags of variables that are ad hoc to the firm's price-decision problem. Researchers have also conventionally used real unit labor cost (RULC) as the proxy for real marginal cost even though it is difficult to support its significance. This paper introduces a new proxy for the real marginal cost term as well as a new instrument set, both of which are based on the micro foundations of the vertical chain of production. I find that the new proxy, based on input prices as opposed to wages, provides a more robust and significant fit to the model. Instruments that are based on the vertical chain of production appear to be both more valid and relevant toward the model.