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The role of expectations in the inflation process in the euro area

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  • Paloviita, Maritta
  • Virén, Matti

Abstract

This paper analyses the role of inflation expectations in the euro area. On one hand, the question is how inflation expectations affect both inflation and output,and, on the other hand, how inflation expectations reflect developments in these variables. The analyses make use of a simple VAR model of inflation, inflation expectations and the output gap that allows for an analysis of the dynamic interrelationship between these variables. This model is estimated on aggregate euro area data, pooled euro area country data and individual country data for the period 1979–2003. The empirical results give strong support for the idea that inflation expectations are the key ingredient of the inflationary process for the whole euro area and for most individual countries as well. Inflation expectations also have a significant negative impact on output. As for the determination of inflation expectations, it turns out that they are relatively persistent, almost as persistent as output. Even so, and especially in the medium term, inflation expectations adapt to developments in both output and (actual) inflation.

Suggested Citation

  • Paloviita, Maritta & Virén, Matti, 2005. "The role of expectations in the inflation process in the euro area," Bank of Finland Research Discussion Papers 6/2005, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2005_006
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    References listed on IDEAS

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    Cited by:

    1. Paloviita, Maritta, 2005. "Comparing alternative Phillips curve specifications: European results with survey-based expectations," Bank of Finland Research Discussion Papers 22/2005, Bank of Finland.
    2. Paloviita, Maritta, 2007. "Estimating a small DSGE model under rational and measured expectations: some comparisons," Bank of Finland Research Discussion Papers 14/2007, Bank of Finland.

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    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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