The New Keynesian Phillips Curve In A Small Open Economy

This study estimates the new Keynesian Phillips curve (NKPC) of Gali and Monacelli for a small open economy using Australian data. Our detailed investigation hinges on estimating the structural parameters in five different variants of the Gali-Monacelli NKPC, which relates the inflation process to terms of trade and the real exchange rate; the marginal cost and output gap as proxies for real economic activity and the hybrid version incorporating both forward- and backward-looking inflation expectations. The analysis and extensive robustness checks overwhelmingly establish that the Gali-Monacelli NKPC cannot explain the dynamics of inflation and is rejected by the Australian data.