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446 - The improbable renaissance of the Phillips curve: The crisis and euro area inflation dynamics

Author(s): Lourdes Acedo Montoya, Björn Döhring, European Commission

The improbable renaissance of the Phillips curve: The crisis and euro area inflation dynamicspdf(625 kB) Choose translations of the previous link 

Summary for non-specialistspdf(78 kB) Choose translations of the previous link 

Why has euro area (core) inflation not fallen further during and after the "great recession"? How different are inflation dynamics across Member States? This paper analyses core inflation dynamics in the euro area and its Member States using a hybrid specification of the Phillips curve. Inflation expectations are directly observed from an expert survey, so no assumptions need to be imposed about expectations formation. The choice of the hybrid Phillips curve framework is vindicated, as the data clearly indicate the relevance of both backward-looking inflation and inflation expectations. The impact of the output gap on core inflation is significant but not large. The combination of stable inflation expectations, sluggish price adjustment and an only moderate impact of the output gap on inflation helps understanding the stability of core inflation despite large and persistent output gaps in the aftermath of the crisis. Although the heterogeneity of Phillips curve relationships across Member States is not large, the exceptionally large output gap caused by the crisis is one driver (among others) of the recently observed inflation differentials in the euro area.

(European Economy. Economic Papers 446. October 2011. Brussels. PDF. 37pp. Tab. Graph. Bibliogr. Free.)

KC-AI-11-446-EN-N (online)
ISBN 978-92-79-19230-2 (online)
doi: 10.2765/11393 (online)

JEL classification: E31, E32, C26

Economic Papers are written by the staff of the Directorate-General for Economic and Financial Affairs, or by experts working in association with them. The Papers are intended to increase awareness of the technical work being done by staff and to seek comments and suggestions for further analysis. The views expressed are the author’s alone and do not necessarily correspond to those of the European Commission.

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