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The improbable renaissance of the Phillips curve: The crisis and euro area inflation dynamics

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  • Lourdes Acedo Montoya
  • Björn Döhring

Abstract

Why has euro area (core) inflation not fallen further during and after the "great recession"? How different are inflation dynamics across Member States? This paper analyses core inflation dynamics in the euro area and its Member States using a hybrid specification of the Phillips curve. Inflation expectations are directly observed from an expert survey, so no assumptions need to be imposed about expectations formation. The choice of the hybrid Phillips curve framework is vindicated, as the data clearly indicate the relevance of both backward-looking inflation and inflation expectations. The impact of the output gap on core inflation is significant but not large. The combination of stable inflation expectations, sluggish price adjustment and an only moderate impact of the output gap on inflation helps understanding the stability of core inflation despite large and persistent output gaps in the aftermath of the crisis. Although the heterogeneity of Phillips curve relationships across Member States is not large, the exceptionally large output gap caused by the crisis is one driver (among others) of the recently observed inflation differentials in the euro area.

Suggested Citation

  • Lourdes Acedo Montoya & Björn Döhring, 2011. "The improbable renaissance of the Phillips curve: The crisis and euro area inflation dynamics," European Economy - Economic Papers 2008 - 2015 446, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
  • Handle: RePEc:euf:ecopap:0446
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    Cited by:

    1. repec:aea:aecrev:v:107:y:2017:i:7:p:1904-37 is not listed on IDEAS
    2. Philippe Martin & Thomas Philippon, 2017. "Inspecting the Mechanism: Leverage and the Great Recession in the Eurozone," American Economic Review, American Economic Association, vol. 107(7), pages 1904-1937, July.
    3. Stefano Scalone, 2014. "Embedding Liquidity Information in Estimating Potential Output," Working Papers 20/2014, University of Verona, Department of Economics.
    4. repec:kap:empiri:v:44:y:2017:i:2:d:10.1007_s10663-016-9322-x is not listed on IDEAS
    5. Oinonen, Sami & Paloviita, Maritta & Vilmi, Lauri, 2013. "How have inflation dynamics changed over time? : Evidence from the euro area and USA," Research Discussion Papers 6/2013, Bank of Finland.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • C26 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Instrumental Variables (IV) Estimation

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