ABSTRACT
This chapter examines the relationship between the output gap and inflationcommonly referred to as the Phillips curve. Once the Phillips curve involves dynamic terms in inflation, a lower mark-up need not always be associated with a rise in current inflation. The requirements of the data set are substantial: it must allow us accurately to measure flexible-price output, to identify and strip out flexible-price inflation, and to model the dynamic processes that related both to underlying demand shocks. Although the Phillips curve is one route to modelling the effect of demand shocks on inflation, there are alternative structures that may tell us more about what drives inflation than relying on a poorly measured output gap in an unreliable Phillips curve. Phillips curve when inflation is far from zero Developing countries tend to have high or trending inflation rates.
