8/2019 Dmitry Kulikov, Nicolas Reigl. Inflation Expectations in Phillips Curve Models for the Euro Area

Working Papers of Eesti Pank 8/2019

This paper takes a fresh look at the use of the Phillips curve and various inflation expectation proxies for tracking euro area inflation dynamics in the aftermath of the global financial crisis of 2008. Because inflation expectations can be measured in a multitude of alternative ways and the Phillips curve model itself is subject to many potential specification choices, we employ a novel thick modelling perspective that is data and model-agnostic and estimate a large number of different Phillips curve models using different data series for different components of our models. We find that Phillips curve models without any forward-looking expectational terms are uniformly the worst predictors of euro area inflation rates after 2013, when measured for the RMSE criterion across all models and specifications. This result underlines the importance of inflation expectations in tracking the recent dynamics of euro area inflation and shows that inflation persistence alone or in combination with different slack and cost push terms cannot satisfactorily explain the euro area inflation story during the period of missing inflation after 2012. We also illustrate the usefulness of the thick modelling approach for practical modelling and forecasting of the euro area inflation series.

JEL Codes: E31, E37, E58, C13, C15, C52
Keywords: data-rich models, thick modelling, data and model uncertainty, Phillips curve, inflation expectations, inflation dynamics, euro area

Dmitry Kulikov (corresponding author): Eesti Pank. E-mail: dmitry.kulikov [at] eestipank.ee. Nicolas Reigl: Eesti Pank. E-mail: nicolas.reigl [at] eestipank.ee.

The views expressed are those of the authors and do not necessarily represent the official views of the Eesti Pank or the Eurosystem.