Inflation dynamics: forward or backward looking?

This study tests the hybrid New Keynesian Phillips curve using a novel panel dataset of the 50 US states from 1977 to 2018. The results suggest that the hybrid New Keynesian Phillips curve is a robust representation of the evolution of US inflation, and emphasise the role of unit labour cost as a driving variable. Consistent with Galt and Gertler (1999), we find relatively larger weights for future inflation than for lagged inflation. This finding confirms the theory of forward-looking behaviour. Furthermore, we obtain more evidence of domi-nant forward-looking behaviour by using principal component-based instruments, finding that using principal components is a good option to overcome weak identifications.