Surprise! Euro area inflation has fallen

Marianna Riggi () and Fabrizio Venditti

No 237, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: Between 2013 and 2014, following the recession triggered by the sovereign debt crisis, euro-area inflation decreased sharply. Although a fall in the inflation rate was to be expected, given the severity of the recession, professional forecasters failed to anticipate it. A possible explanation for this forecast failure lies in a break in the cyclicality of inflation, which was unaccounted for in forecasting models. We probe this explanation in the context of a simple backward-looking Phillips curve and find that the sensitivity of inflation to the output gap has recently increased. We rationalize this result through a structural model, in which a steepening of the Phillips curve arises either from lower nominal rigidities (a decrease in the average duration of prices) or from fewer strategic complementarities in price-setting due to a reduction in the number of firms in the economy.

Keywords: inflation; Phillips curve; structural break; strategic complementarities (search for similar items in EconPapers)
JEL-codes: C53 E31 E37 (search for similar items in EconPapers)
Date: 2014-09
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (33)

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Persistent link: https://EconPapers.repec.org/RePEc:bdi:opques:qef_237_14

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