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Inflation dynamics in the euro area and the role of expectations

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  • Paloviita , Maritta

    ()
    (Bank of Finland Research)

Abstract

This paper assesses empirically the two main alternative specifications of the output gap-based Phillips relation for the euro area: the older expectations-augmented Phillips curve and the new Keynesian Phillips curve. The main focus is on the role of expectations and comparison of the two theories. Instead of imposing rational expectations, an alternative and in principle less restrictive approach is applied to operationalising expectations. Direct measures of inflation expectations, ie OECD forecasts, are used as empirical proxies of economic agents’ inflation expectations. The main interest is in the euro area as a whole, although potential heterogeneity of inflation dynamics is also examined across eleven EMU countries. According to the results, inflation expectations are central to the inflation process in all euro area countries. The paper finds evidence that the new Keynesian Phillips curve fits the euro area data slightly better than the expectations-augmented Phillips curve. Research on expectations formation would be an important complement to the present study.

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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 20/2002.

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Length: 43 pages
Date of creation: 09 Sep 2002
Date of revision:
Handle: RePEc:hhs:bofrdp:2002_020

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: Phillips curve; expectations; euro area;

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  1. Klaus Adam & Mario Padula, 2011. "Inflation Dynamics And Subjective Expectations In The United States," Economic Inquiry, Western Economic Association International, vol. 49(1), pages 13-25, 01.
  2. Argia M. Sbordone, 2001. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Departmental Working Papers 199822, Rutgers University, Department of Economics.
  3. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  4. Benigno, Pierpaolo & Lopez-Salido, J. David, 2006. "Inflation Persistence and Optimal Monetary Policy in the Euro Area," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 587-614, April.
  5. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  6. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," NBER Working Papers 7988, National Bureau of Economic Research, Inc.
  7. Jordi Gali & Mark Gertler & J. David Lopez-Salido, 2001. "European Inflation Dynamics," NBER Working Papers 8218, National Bureau of Economic Research, Inc.
  8. Roberts, John M., 1997. "Is inflation sticky?," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 173-196, July.
  9. John M. Roberts, 1998. "Inflation expectations and the transmission of monetary policy," Finance and Economics Discussion Series 1998-43, Board of Governors of the Federal Reserve System (U.S.).
  10. Katharine Neiss & Edward Nelson, 2002. "Inflation dynamics, marginal cost, and the output gap: evidence from three countries," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  11. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  12. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  13. Ash, J. C. K. & Smyth, D. J. & Heravi, S. M., 1998. "Are OECD forecasts rational and useful?: a directional analysis," International Journal of Forecasting, Elsevier, vol. 14(3), pages 381-391, September.
  14. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  15. Jeremy Rudd & Karl Whelan, 2002. "Should monetary policy target labor's share of income?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  16. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  17. Edith Gagnon & Hashmat Khan, 2001. "New Phillips Curve with Alternative Marginal Cost Measures forCanada, the United States, and the Euro Area," Working Papers 01-25, Bank of Canada.
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