Research Discussion Papers, Bank of Finland
Inflation dynamics in the euro area and the role of expectations: further results
Abstract: This paper examines the empirical performance of the New
Keynesian Phillips curve and its hybrid specification in the euro area.
Instead of imposing rational expectations, direct measures, ie OECD
forecasts, are used as empirical proxies for economic agents´ inflation
expectations. Real marginal costs are proxied by three different measures.
The results suggest that OECD inflation forecasts perform relatively well
as a proxy for inflation expectations in the euro area, since under this
approach the European inflation process can be modeled using the
forward-looking New Keynesian Phillips curve. However, inflation can be
modeled even more accurately by the hybrid Phillips curve. Thus, even
allowing for possible non-rationality in expectations, the additional
lagged inflation term is needed in the New Keynesian Phillips relation. In
this approach, the output gap turns out to be at least as good a proxy for
real marginal costs as the labor income share. Moreover, the inflation
process seems to have become more forward-looking in the recent years of
low and stable inflation.
Keywords: Phillips curve; expectations; euro area; (follow links to similar papers)
JEL-Codes: C52; E31; (follow links to similar papers)
28 pages, October 13, 2004
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- This paper is published as:
Paloviita, Maritta, (2006), 'Inflation dynamics in the euro area and the role of expectations', Empirical Economics, Vol. 31, pages 847-860
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