7/2007 Aurelijus Dabušinskas ja Dmitry Kulikov. New Keynesian Phillips curve for Estonia, Latvia and Lithuania

Working Papers of Eesti Pank. No 7/2007

This paper presents an empirical analysis of the inflation process in Estonia, Latvia and Lithuania within the framework of the New Keynesian Phillips Curve (NKPC) model of Galí and Gertler (1999) and Galí et al. (2001). An open economy extension by Leith and Malley (2003) and a NKPC model that explicitly incorporates energy into the average real marginal cost measure are also considered. The primary focus of the paper is to identify and compare the underlying structural parameters of the NKPC model across the three Baltic economies.
Empirical NKPC model estimates point to a limited role of the cost measure in determining inflation dynamics in the three Baltic countries. It has been found that the inflation process in these countries primarily depends on inflation expectations and past inflation rates. Price setting flexibility, as measured by the price stickiness parameter, tends to be lower than in the euro area but higher than in the US, while the share of backward-looking price setters is found to be higher on average.
JEL Code: E31, C22
Key words: New Keynesian Phillips Curve, inflation dynamics, open economy, GMM

* We wish to thank participants of the Eesti Pank research seminar (Tallinn), the Fourth ESCB Workshop on Emerging Markets (Helsinki), the 62nd International Atlantic Economic Conference (Philadelphia), the 1st All China Economics Conference (Hong Kong) and the 2nd Estonian Economic Association Conference (Pärnu) for helpful comments and suggestions. We are particularly grateful to David Mayes and Karsten Staehr for their input. The usual disclaimer applies.

Authors' e-mail addresses: aurelijus.dabusinskas [at] epbe.ee, dmitry.kulikov [at] epbe.ee

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

Contents

1. Introduction
2. Theoretical framework
2.1. Closed economy model
2.2. Open economy extensions
2.3. Oil price and marginal cost
2.4. Some concerns
3. Data and econometric methodology
4. Empirical results
5. Conclusions
References

New Keynesian Phillips curve for Estonia, Latvia and Lithuania, Working Papers of Eesti Pank No 7/2007 (PDF*)

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