Literature Review Macroeconomics

(Roberts, 1995) explains the Phillips Curve in relation to New Keynesian Economics. The
fundamental aspect of this paper is the consensus of sticky prices in Keynesian models and the
augmented Phillips Curve. Roberts outlines the price setting in Keynesian economic models with
regard to future expectations. His paper builds upon previous works such as those of (Rotemberg,
1982) and (Taylor, 1980), where expectations were explained under rational expectations of
consumers. The aforementioned studies were conducted with full information techniques. A
significant flaw of this technique is if any variable in the model is not specified, the results will vary
considerably. Taking this into account, Roberts explored two limited information approaches.
(McCallum, 1976) uses the actual value of a variable thereby reducing the information used in the
estimation process. One major advantage this has over full information techniques is that it is not
necessary to have the complete economic model.
New Keynesian thought has bifurcated sticky price models into two main categories, “state
dependant” and “time dependant.” There are various distinctions between the two models. In the
former, firms change their price when determinants such as demand and costs start to fluctuate.
Contrarily, time dependant models often keep their prices unchanged for periods of times. Time
determinant models often have explicit closed solutions. State determined solutions, generally
speaking, do not have closed solutions. In fact, for some models average price adjustment may take
place instantly regardless of whether prices are sticky or not. (Roberts, 1995) explicitly mentions
the lack of time dependant models in his analysis. This proves to be a serious insufficiency in his
paper. He primarily focuses on state dependant models due to the volatility of prices.
(Rudd & Whelan, 2005) further expands on this this New Keynesian perspective by
performing several tests on the Phillips Curve. They attempted to study the effect of lagged
dependant variables in inflation models. Building on (Roberts, 1995), this paper tries to understand
if this lag acts as a proxy for forward looking expectations. Alternatively, these lag variables could
reflect backward looking inflationary expectations. Through the paper (Rudd & Whelan, 2005)
show that the tests conducted by (Gali & Gertler, 1999) are not accurate when tested against
backward looking specifications. They resort to using an unorthodox methodology to show that the
Keynesian pricing model is unable to explain the significance of lagged inflation. This implies that
forward looking expectations play little to no role in determining inflation.
 References
Roberts, J. M. (1995). New Keynesian Economics and the Phillips Curve. Journal of Money, Credit
and Banking, 27(4), 975–984. https://doi.org/10.2307/2077783

Rudd, J., & Whelan, K. (2005). New tests of the new-Keynesian Phillips curve. Journal of
Monetary Economics, 52(6), 1167–1181. https://doi.org/10.1016/j.jmoneco.2005.08.006

Pindyck, R. S., & Rotemberg, J. (1982, November). Dynamic Factor Demands Under Rational
Expectations. NBER Working Papers; National Bureau of Economic Research, Inc.
https://ideas.repec.org/p/nbr/nberwo/1015.html

Clarida, R., Galí, J., & Gertler, M. (1999). The Science of Monetary Policy: A New Keynesian
Perspective. Journal of Economic Literature, 37(4), 1661–1707.
https://doi.org/10.1257/jel.37.4.1661