Inflation dynamics: a traditional perspective

Abstract

Abstract We derive a traditional Phillips curve (TPC) under the assumption that a fraction of firms sells output at optimal prices, while the other fraction sells at contract prices. Our derivation delivers a pricing mechanism where inflation depends on expected inflation and the real optimal price, which is the real marginal cost. The parameters of this Phillips curve have a clear structural interpretation in much the same way as its new Keynesian counterpart.. Using a Leontief-type technology, our baseline TPC features expected inflation, the labour share, demand pressure and a vector of supply shocks. We estimate this TPC for five developed and five emerging market economies and find that the degree of price rigidity is significant and correctly signed in most of the economies. We conclude that this TPC is a credible rival to its forward-looking new Keynesian counterpart.