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The Nonlinearity of the Phillips Curve and European Monetary Policy

  • Pyyhtiä, Ilmo

    (Bank of Finland Research)

Registered author(s):

    This paper deals with the question of whether the euro area Phillips curve is nonlinear. There has recently been a great deal of discussion and studies concerning the same question in the US context. The data set includes most of the euro area countries, namely Austria, Germany, Finland, France, Italy, the Netherlands and Spain. Estimation is made both with pooled data and with country-specific models. The results give a clear indication of nonlinearity of the Phillips curve in many euro countries. The curve is asymmetric in the sense that, with a positive output gap (actual output is greater than potential output), its impact on inflation is positive, but, with a negative output gap, the deflationary impact is very small and not significant as a rule. The Phillips curve has been especially asymmetric in Germany, Finland, Italy, the Netherlands and Spain. An important result of the study is the strong negative influence of inflation uncertainty on GDP in the euro countries during the estimation period, 1976-1997. This effect was very strong in pooled data but also at country level. This result is new in the sense that a Lucas-type supply function and especially nonlinear versions of it have not been estimated very often. Another interesting result is that Phillips curves can be estimated with good success using OECD Secretariat forecast data for inflation expectations. A very important result for monetary policy are the large differences between countries as regards the slope and shape of the Phillips curve. The policy implication of nonlinearity is clear. The costs of unduly expansive monetary policy could be high in the euro area in the medium term. Nonlinearity also means that inflation pressure in the euro area is dependent not only on the average demand situation but also on how economic activity is distributed across the region.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/9917.pdf
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    Paper provided by Bank of Finland in its series Research Discussion Papers with number 17/1999.

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    Length: 37 pages
    Date of creation: 26 Nov 1999
    Date of revision:
    Handle: RePEc:hhs:bofrdp:1999_017
    Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/

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    1. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
    2. Robert J. Gordon, 1996. "The Time-Varying NAIRU and its Implications for Economic Policy," NBER Working Papers 5735, National Bureau of Economic Research, Inc.
    3. Douglas Laxton & Guy Meredith & David Rose, 1994. "Asymmetric Effects of Economic Activityon Inflation; Evidence and Policy Implications," IMF Working Papers 94/139, International Monetary Fund.
    4. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    5. Eric Schaling, 1999. "The non-linear Phillips curve and inflation forecast targeting," Bank of England working papers 98, Bank of England.
    6. Cecchetti, Stephen G & McConnell, Margaret M & Perez-Quiros, Gabriel, 2002. "Policymakers' Revealed Preferences and the Output-Inflation Variability Trade-Off: Implications for the European System of Central Banks," Manchester School, University of Manchester, vol. 70(4), pages 596-618, Special I.
    7. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
    8. P Clark & D Laxton, 1997. "Phillips Curves," CEP Discussion Papers dp0344, Centre for Economic Performance, LSE.
    9. Douglas Laxton & Peter B. Clark & David Rose, 1995. "Asymmetry in the U.S. Output-Inflation Nexus; Issues and Evidence," IMF Working Papers 95/76, International Monetary Fund.
    10. David Mayes & Bryan Chapple, 1995. "The costs and benefits of disinflation: a critique of the sacrifice ration," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 58, March.
    11. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
    12. Stephen G. Cecchetti & Robert W. Rich, 1999. "Structural estimates of the U.S. sacrifice ratio," Staff Reports 71, Federal Reserve Bank of New York.
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