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Inflation dynamics in the euro area and the role of expectations: further results

  • Paloviita , Maritta

    ()

    (Bank of Finland Research)

This paper examines the empirical performance of the New Keynesian Phillips curve and its hybrid specification in the euro area. Instead of imposing rational expectations, direct measures, ie OECD forecasts, are used as empirical proxies for economic agents´ inflation expectations. Real marginal costs are proxied by three different measures. The results suggest that OECD inflation forecasts perform relatively well as a proxy for inflation expectations in the euro area, since under this approach the European inflation process can be modeled using the forward-looking New Keynesian Phillips curve. However, inflation can be modeled even more accurately by the hybrid Phillips curve. Thus, even allowing for possible non-rationality in expectations, the additional lagged inflation term is needed in the New Keynesian Phillips relation. In this approach, the output gap turns out to be at least as good a proxy for real marginal costs as the labor income share. Moreover, the inflation process seems to have become more forward-looking in the recent years of low and stable inflation.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0421.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 21/2004.

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Length: 28 pages
Date of creation: 13 Oct 2004
Date of revision:
Publication status: Published in Empirical Economics, 2006, pages 847-860.
Handle: RePEc:hhs:bofrdp:2004_021
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. John M. Roberts, 1994. "Is inflation sticky?," Working Paper Series / Economic Activity Section 152, Board of Governors of the Federal Reserve System (U.S.).
  2. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 265-292, March.
  3. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  4. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," NBER Working Papers 7988, National Bureau of Economic Research, Inc.
  5. Roberts John M., 2005. "How Well Does the New Keynesian Sticky-Price Model Fit the Data?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-39, September.
  6. Galí, Jordi & Gertler, Mark & López-Salido, J David, 2001. "European Inflation Dynamics," CEPR Discussion Papers 2684, C.E.P.R. Discussion Papers.
  7. Paloviita , Maritta, 2002. "Inflation dynamics in the euro area and the role of expectations," Research Discussion Papers 20/2002, Bank of Finland.
  8. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  9. Michael J. Artis, 1996. "How Accurate Are the Imf's Short-Term Forecasts? Another Examination of the World Economic Outlook," IMF Working Papers 96/89, International Monetary Fund.
  10. 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.
  11. 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.
  12. 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.).
  13. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  14. 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.
  15. Forsells, Magnus & Kenny, Geoff, 2002. "The rationality of consumers' inflation expectations: survey-based evidence for the euro area," Working Paper Series 0163, European Central Bank.
  16. Jeremy Rudd & Karl Whelan, 2002. "Should monetary policy target labor's share of income?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  17. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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