Research Discussion Papers, Bank of Finland
No 17/1999:
The Nonlinearity of the Phillips Curve and European Monetary Policy
Ilmo Pyyhtiä
Abstract: 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.
Keywords: Phillips curve; nonlinearity; monetary policy; uncertainty; euro area country differences; (follow links to similar papers)
37 pages, November 26, 1999
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