Research Discussion Papers, Bank of Finland
No 6/2005:
The role of expectations in the inflation process in the euro area
Maritta Paloviita ()
and Matti Virén ()
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.
Keywords: inflation; expectations; monetary policy; Phillips curve; (follow links to similar papers)
JEL-Codes: E31; E52; (follow links to similar papers)
37 pages, February 13, 2005
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