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Surprise! Euro area inflation has fallen

Author

Listed:
  • Marianna Riggi

    (Bank of Italy)

  • Fabrizio Venditti

    (Bank of Italy)

Abstract

Between 2013 and 2014, following the recession triggered by the sovereign debt crisis, euro-area inflation decreased sharply. Although a fall in the inflation rate was to be expected, given the severity of the recession, professional forecasters failed to anticipate it. A possible explanation for this forecast failure lies in a break in the cyclicality of inflation, which was unaccounted for in forecasting models. We probe this explanation in the context of a simple backward-looking Phillips curve and find that the sensitivity of inflation to the output gap has recently increased. We rationalize this result through a structural model, in which a steepening of the Phillips curve arises either from lower nominal rigidities (a decrease in the average duration of prices) or from fewer strategic complementarities in price-setting due to a reduction in the number of firms in the economy.

Suggested Citation

  • Marianna Riggi & Fabrizio Venditti, 2014. "Surprise! Euro area inflation has fallen," Questioni di Economia e Finanza (Occasional Papers) 237, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:opques:qef_237_14
    as

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    File URL: https://www.bancaditalia.it/pubblicazioni/qef/2014-0237/QEF-237.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    inflation; Phillips curve; structural break; strategic complementarities;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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