Research Discussion Papers, Bank of Finland
No 16/2008:
Estimating open economy Phillips curves for the euro area with directly measured expectations
Maritta Paloviita ()
Abstract: This paper examines euro area inflation dynamics by
estimating open economy New Keynesian Phillips curves based on the
assumption that all imports are intermediate goods. Instead of imposing
rational expectations a priori, Consensus Economics survey data and OECD
inflation forecasts are used to proxy inflation expectations. The results
suggest that, compared with a closed economy New Keynesian Phillips curve,
euro area inflation dynamics are better captured by the open economy
specification. Moreover, in the open economy context, and even if we allow
for persistence in expectations, the hybrid specification of the New
Keynesian Phillips curve is needed in order to capture the euro area
inflation process properly. We also provide some evidence that in recent
years of low and stable inflation, euro area inflation dynamics have become
more forward-looking and the link between inflation and domestic demand has
weakened (ie the euro area Phillips curve has flattened). On the other
hand, in low-inflation euro area countries the inflation process seems to
have been more forward-looking already since the early 1980s.
Keywords: New Keynesian Phillips curve; open economy; expectations; euro area; (follow links to similar papers)
JEL-Codes: C52; E31; F41; (follow links to similar papers)
37 pages, June 25, 2008
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