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Estimated Open Economy New Keynesian Phillips Curves for the G7

By Campbell Leith and Jim Malley

Abstract

In this paper we develop an open economy model of firms’ pricing be-haviour under imperfect competition. This allows us to introduce various terms of trade e .ects influencing the firm’s pricing decision, in addition to labour costs which dominate most closed-economy specifications of the New Keynesian Phillips (NKPC) curve. Our analysis gives rise to a hy-brid open economy NKPC which nests existing closed and open economy specifications adopted in empirical work. We estimate this specification for the G7 economies and find that the US, UK and Canada typically enjoy less inertia in price setting than the European G7 economies and Japan andthattheseestimatesareboth plausibleand in linewith sur-vey evidence. We also find that the proportion of firms which use simple backward-looking rules of thumb in price setting is greater when the fre-quency of price change is smaller. Finally there is evidence of significant asymmetries in price setting amongst EMU members.

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