Trend Inflation and the New Keynesian Phillips Curve

We investigate the nature of structural breaks in the dynamics of U.S. inflation, in the presence of a stochastic trend in inflation. This is done by de-riving and estimating unobserved component trend-cycle models of inflation that are consistent with the New Keynesian Phillips Curve. Our derivation suggests that the transitory component of inflation is a function of real eco-nomic activity and a potentially serially correlated component, with the latter signifying the importance of the backward-looking component. Our empiri-cal results suggest that a forward-looking Phillips curve can provide a good fit to postwar U.S. inflation data, except for the period of the Great Inflation in the 1970s. These results imply that the relatively poor performance of re-cursive and rolling AR forecasts of inflation in the last decades results from a disappearance of the backward-looking component in the Phillips curve in the early 1980s. Furthermore, the models presented in this paper display good in-sample and out-of-sample forecasting abilities relative to benchmark models in the literature that forecast inflation well