Non-linear Dynamics of the NKPC and Inflation Misalignment

This paper examines the nonlinear dynamics of inflation within the hybrid NKPC framework and inflation misalignment for five inflation-targeting countries using quarterly data from 1960 to 2012. We first test the validity of a linear NKPC and find strong evidence rejecting linearity, particularly with respect to lagged inflation. Inflation dynamics are shown to be inherently nonlinear and characterized by regime-switching behavior driven by past inflation levels. To capture these features, we employ an ESTR model, which successfully models the nonlinear hybrid NKPC across all countries, with faster transition speeds observed in Australia and Canada.The analysis is then extended to inflation misalignment from target to assess whether inflation persistence reflects a linear long-memory process or regime changes. The results support the regime-switching hypothesis, indicating that inflation misalignment dynamics are predominantly nonlinear. Overall, the findings emphasize the importance of accounting for nonlinear inflation dynamics when evaluating inflation-targeting frameworks and the effectiveness of monetary policy, especially during periods of rising inflationary pressures.