Trend inflation, indexation, and inflation persistence in the new Keynesian Phillips curve

A number of empirical studies conclude that purely forward-looking versions of the New Keynesian Phillips curve (NKPC) generate too little inflation per-sistence. Some authors add ad hoc backward-looking terms to address this shortcoming. In this paper, we hypothesize that inflation persistence results mainly from variation in the long-run trend component of inflation, attributable to shifts in monetary policy, and that the apparent need for lagged inflation in the NKPC comes from neglecting the interaction between drift in trend in-flation and non-linearities in a more exact version of the model. We derive a version of the NKPC as a log-linear approximation around a time-varying inflation trend and examine whether such a model explains the dynamics of in-flation around that trend. When drift in trend inflation is taken into account, there is no need for a backward-looking indexation component, and a purely forward-looking version of the model fits the data well. JEL Classification: E31. Keywords: Trend inflation; Inflation persistence; Phillips curve; time-varying VAR