Research Discussion Papers, Bank of Finland
No 20/2002:
Inflation dynamics in the euro area and the role of expectations
Maritta Paloviita ()
Abstract: 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.
Keywords: Phillips curve; expectations; euro area; (follow links to similar papers)
JEL-Codes: C52; E31; (follow links to similar papers)
43 pages, September 9, 2002
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