Is the Irish Phillips Curve broken?

Contrary to the predictions of a traditional Phillips curve relationship, inflation in Ireland has remained subdued in recent years, regardless of improving labour market conditions before the covid-19 outbreak. To examine this apparent puzzle, we test econometrically the relevance of the Phillips curve in Ireland between 1999 and 2018. Linear regressions provide robust evidence that inflation does react to cyclical conditions both in Ireland and in its main trading partners. We also find that inflation dynamics are largely imported, in particular through imports from the UK. Low import prices have partly offset the upward pressures exerted by cyclical variables and contributed to the subdued inflation observed in recent years. We also investigate whether the Irish Phillips curve may be non-linear. We find some evidence that the Phillips curve is flatter when there are high excess capacities and turns steeper as economic slack is eliminated. However, when comparing different specifications on the basis of their pseudo out-of-sample forecasting performance, we find that non-linear specifications do not systematically outperform linear specifications.