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Estimating open economy Phillips curves for the euro area with directly measured expectations

  • Paloviita, Maritta


    (Bank of Finland Research)

This paper examines euro area inflation dynamics by estimating open economy New Keynesian Phillips curves based on the assumption that all imports are intermediate goods. Instead of imposing rational expectations a priori, Consensus Economics survey data and OECD inflation forecasts are used to proxy inflation expectations. The results suggest that, compared with a closed economy New Keynesian Phillips curve, euro area inflation dynamics are better captured by the open economy specification. Moreover, in the open economy context, and even if we allow for persistence in expectations, the hybrid specification of the New Keynesian Phillips curve is needed in order to capture the euro area inflation process properly. We also provide some evidence that in recent years of low and stable inflation, euro area inflation dynamics have become more forward-looking and the link between inflation and domestic demand has weakened (ie the euro area Phillips curve has flattened). On the other hand, in low-inflation euro area countries the inflation process seems to have been more forward-looking already since the early 1980s.

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Paper provided by Bank of Finland in its series Research Discussion Papers with number 16/2008.

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Length: 37 pages
Date of creation: 25 Jun 2008
Date of revision:
Handle: RePEc:hhs:bofrdp:2008_016
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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