How relevant is the new (Keynesian) Phillips Curve? : the case of Turkey

The new Keynesian microfoundations provide a new perspective in understanding inflation output trade-off or policy effectiveness phenomena. Roughly speaking, the New Keynesian theory can be described as an attempt to re-formulate the familiar Phillips Curve on the basis of new microfoundations. According to this new formulation of the relationship between effects of demand shocks and price-setting behaviour, average inflation is one of the most important determinants of the degree of the trade-off. In high inflationary environments, agents are more willing to revise their prices, while in a low inflationary environment, they may ignore and postpone price adjustment as a reaction to a series of demand shocks. To test the relevancy of such a claim related to the Phillips Curve, a generalised impulse-response analysis is performed by using Turkish data which can easily be divided into two periods. In the first period between 1988:Q3 and 1996:Q1, inflation rates in the Turkish economy have increased, and in the second (from 1996:Q2 to 2003:Q4), it has been decreasing. The findings of this study support the hypothesis that "price adjustment frequency decreases (rises) sharply with lower (higher) rates of inflation, reducing the real effect of inflation on output", as claimed by Devereux and Yetman (2002:95). (J Eco Coop Isl Count/DÜI)