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Inflation dynamics in the euro area and the role of expectations

  • Maritta Paloviita

    (Bank of Finland)

Registered author(s):

    This paper assesses empirically the two main alternative specifications of the output gap-based Phillips relation for the euro area: the older expectations-augmented Phillips curve and the new Keynesian Phillips curve. The main focus is on the role of expectations and comparison of the two theories. Instead of imposing rational expectations, an alternative and in principle less restrictive approach is applied to operationalising expectations. Direct measures of inflation expectations, ie OECD forecasts, are used as empirical proxies of economic agents’ inflation expectations. The main interest is in the euro area as a whole, although potential heterogeneity of inflation dynamics is also examined across eleven EMU countries. According to the results, inflation expectations are central to the inflation process in all euro area countries. The paper finds evidence that the new Keynesian Phillips curve fits the euro area data slightly better than the expectations-augmented Phillips curve. Research on expectations formation would be an important complement to the present study.

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    File URL: http://econwpa.repec.org/eps/mac/papers/0405/0405015.pdf
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    Paper provided by EconWPA in its series Macroeconomics with number 0405015.

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    Date of creation: 14 May 2004
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    Handle: RePEc:wpa:wuwpma:0405015
    Note: Type of Document - pdf
    Contact details of provider: Web page: http://econwpa.repec.org

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    1. Argia M. Sbordone, 2001. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Departmental Working Papers 199822, Rutgers University, Department of Economics.
    2. Pierpaolo Benigno & David López-Salido, 2002. "Inflation persistence and optimal monetary policy in the euro area," International Finance Discussion Papers 749, Board of Governors of the Federal Reserve System (U.S.).
    3. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
    4. King, Robert G. & Watson, Mark W., 1994. "The post-war U.S. phillips curve: a revisionist econometric history," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 41(1), pages 157-219, December.
    5. Jordi Gali & Mark Gertler & J. David Lopez-Salido, 2001. "European Inflation Dynamics," NBER Working Papers 8218, National Bureau of Economic Research, Inc.
    6. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
    7. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    9. Roberts, John M., 1997. "Is inflation sticky?," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 173-196, July.
    10. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, March.
    11. Cara S. Lown & Robert W. Rich, 1997. "Is there an inflation puzzle?," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 51-77.
    12. Jeremy Rudd & Karl Whelan, 2002. "Should monetary policy target labor's share of income?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    13. 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.).
    14. Edith Gagnon & Hashmat Khan, 2001. "New Phillips Curve with Alternative Marginal Cost Measures forCanada, the United States, and the Euro Area," Working Papers 01-25, Bank of Canada.
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