Asymmetry in the regimes of inflation and business cycles:the New Keynesian Phillips curve

Employing a novel instrumental variable method, we provide three findings with the idea of introducing regime switching into the NKPC for Australia, Canada, New Zealand, the United Kingdom and the United States. First, the response of inflation to the driving force is asymmetric in expansion/contraction, and high/low inflation regimes. The switch between regimes changes the inflation dynamics, thus changing the trade-off between stabilizing inflation and the output gap. Second, price stickiness changes in regimes. The price rigidity explains the inflation-output gap and the inflation-law of one price gap relationship across regimes. Third, inflation dynamics are more forward-looking in the expansionary regime. These results yield the implications of targeting deviations from the law of one price for stabilizing inflation and business cycles.