We apply textual analysis to extract the tone (sentiment) from the introductory statements to the ECB’s press conferences regarding economic outlook. By combining this information with Eurosystem/ECB staff macroeconomic projections, we are able to directly estimate the Governing Council’s loss function. Our analysis suggests that prior to the new monetary policy strategy announced in July 2021, the de facto inflation aim of the ECB may have been considerably below 2%. We also find evidence that the loss function has been asymmetric, which would mean that the ECB has been more averse to inflation above 2% than below 2%. The ECB’s new definition of price stability implies a symmetric loss function with a bliss point at 2.0%. Hence our results indicate that the new strategy will bring about a clear change in the Governing Council’s policy preferences.
This paper examines empirical performance of three different Phillips curve specifications in the euro area.Instead of imposing rational expectations, direct measures, ie OECD forecasts, are used to proxy economic agents' inflation expectations.Real marginal costs are measured in three different ways.The results suggest that with directly measured expectations the estimated New Classical Phillips curve has satisfactory statistical properties. Moreover, the driving variable enters the estimated, purely forward-looking, New Keynesian Phillips curve with the correct sign, but it is clearly outperformed by the New Classical and Hybrid Phillips curves.We interpret our results as indicating that the European inflation process is not purely forwardlooking, so that inflation cannot instantaneously adjust to new information. Consequently, even allowing for possible non-rationality in expectations, a lagged inflation term enters the New Keynesian Phillips curve for European inflation dynamics.The inflation process seems to have become more forward-looking in the recent years of low and stable inflation.Furthermore, in the New Keynesian Phillips curve relationship, the output gap turns out to be at least as good a proxy for real marginal cost as is the labour income share. Key words: Phillips curve, expectations, euro area JEL Classification: E31, C52
Abstract We use administrative and survey-based micro data to study the relationship between cognitive abilities (IQ), the formation of inflation expectations, and the consumption plans of a representative male population. High-IQ men display 50 $\%$ lower forecast errors for inflation than other men. High-IQ men, but not others, have consistent inflation expectations and perceptions over time. In terms of choice, only high-IQ men increase their consumption propensity when expecting higher inflation as the consumer Euler equation prescribes. Education levels, income, other expectations, and socio-economic status, although important, do not explain the variation in expectations and choice by IQ. Recent modelling attempts to incorporate boundedly rational agents into macro models do not fully capture all the facts we document. We discuss which dimensions of expectations formation and choice are important for heterogeneous-agents models of household consumption and for the transmission of fiscal and monetary policy.
This study explores real time uncertainty in euro area fiscal policies since the late 1990s. Using real time data from the OECD Economic Outlook publications we investigate the impact of real time uncertainty on fiscal planning and debt accumulation separately for two country groups in the euro area: countries in geographical periphery (Greece, Ireland, Italy, Portugal and Spain) and other euro area countries (Austria, Belgium, Finland, France, Germany and the Netherlands). The results indicate that real time uncertainty substantially affects fiscal planning. Ex ante fiscal plans have generally been long-term oriented and counter-cyclical in the euro area, but in the periphery countries policies have been more sensitive to economic cycles and less long-term oriented than in the other countries. We find evidence that high indebtedness in the periphery countries cannot be explained by short-term pro-cyclical ex ante fiscal planning. Instead, high initial debt ratios, policy changes after the budget-planning stage and cumulated macroeconomic imbalances have contributed substantially to accumulated debt ratios. Overall, reliable statistics, balanced macroeconomic developments and longer-term policy orientation, which are central in the new EU fiscal framework, are crucial for sound and sustainable public finances. Keywords: fiscal policy, debt accumulation, real time data, cyclical sensitivity, economic crisis JEL classification numbers: E62, E32
The aim of this study is to explore budget planning in the euro area countries in 2004-2014. Our analyses are based on annual real-time data from the IMF World Economic Outlook publications. As forecasts made by different institutions are strongly correlated, our dataset reasonably reflects information available for policy makers in real-time. We examine whether real-time forecasts of overall budget balance, real GDP growth and output gap have been systematically biased. We also analyse forecast accuracy of potential output growth, which we construct using different vintages of real-time data. Our results indicate systematic biases in forecasts. Further, we study how real-time macroeconomic conditions affect budget planning. For comparison, we also consider how ex post economic conditions and ex post budget balance developments are related. We find robust evidence of mean reversion in budget balances, in both real-time and revised data. Mean reversion is related only to negative budget balances, and it is systematically stronger with respect to revised information. Finally, we analyse errors in budget balance forecasts. We provide robust evidence that revisions to current budget balance have contributed to errors in budget balance forecasts. We also find that forecasted macroeconomic conditions (potential output growth and real GDP growth) and their revisions have affected errors in budget balance forecasts. Overall, our results indicate that real-time uncertainty and revisions materially affect budget planning.
The New Keynesian Phillips curve is widely used in macroeconomics and monetary policy analysis. It is explicitly based on micro-foundations, monopolistically competitive firms and sticky prices. In its original form the New Keynesian Phillips curve is purely forward-looking model of inflation dynamics in the closed economy context. It is based on time-contingent price setting, which can be derived using Taylor’s overlapping contracts model (Taylor 1980), Rotemberg’s model of quadratic costs of price adjustment (Rotemberg 1982) or the Calvo (1983) model with random price adjustment. The alternative New Keynesian Hybrid Phillips curve includes elements of both forward- and backward-looking prices setting (Gali and Gertler, 1999). In the hybrid model only some price setters behave optimally when adjusting prices while the rest use rules of thumb or indexation, which is based on recent history of aggregate prices. When the New Keynesian Phillips curve is extended into open economy framework, inflation dynamics become more complicated, as new channels arise due to exchange rate changes and the effects of foreign shocks. In this approach, not only domestic demand and supply, but also foreign economic conditions influence domestic inflation. Imported goods can be modelled as intermediate goods (McCallun and Nelson, 1999, 2000; Kara and Nelson, 2003; Allsopp, Kara and Nelson, 2006), or as final consumption goods (Gali and Monacelli, 2005). Also more complicated models have been investigated (Batini et al, 2005; Leith and Malley, 2007; Rumler, 2007). The exchange rate pass-through is assumed to be full when final consumption goods model is analysed, but incomplete when imported goods are treated as intermediate goods. In this study we examine the empirical relevance of the New Keynesian Phillips curve relationship. Using pooled data for the euro area since the late 1980s, we compare the empirical fit of alternative Phillips curve specifications. We investigate both purely forward-looking models and hybrid models, which include both forwardand backward-looking elements of expectations. In the open economy context, we make the assumption that all imports are intermediate goods. Possible persistence in expectations is taken into account by using direct proxies i.e. Consensus Economics survey data for inflation expectations. The empirical analysis provides the strongest support for the open economy New Keynesian hybrid model. The Wald test of coefficient restrictions suggests that compared with the purely forward-looking specification, euro area inflation dynamics are better captured by the hybrid Phillips curve. Moreover, the empirical performance of the hybrid specification is improved, if the model is extended into open economy context. Robustness analysis indicates that the same open economy hybrid model is appropriate for countries with low and with high output gap volatility. Moreover, the inflation process in the four biggest and in the rest of the countries can be modelled using the same model parameters. Inflation dynamics are a central issue in monetary policy analysis. When conducting monetary policy, the inflation process and the effects of foreign shocks (for example energy and food price shocks) on domestic inflation must be carefully analysed. It is also important to examine how persistent the effects of shocks on inflation are and how the exchange rate and inflation are related. Overall, monetary policy analysis must be based on structural models, which capture expectations dynamics and the open economy aspects of the inflation process accurately. Recently, due to sharply weakening conditions in the world economy and highly volatile commodity prices, maintaining a deep understanding of inflation dynamics in the open economy context has become even more important for central banks.
Using a novel approach based on micro-level survey responses, we assess the reliability of aggregated inflation expectations estimates in the European Commission Consumer Survey. We identify the share of consumers, whose qualitative and quantitative views on expected increase of prices do not match each other. Then we consider the impact of inconsistent survey responses on balance statistics and mean values of quantitative inflation expectations. We also analyze expectations’ formation estimating the sticky-information models. The results, based on Finnish and Polish data, suggest that even if the fraction of inconsistent survey responses is non-negligible, it matters neither for the aggregated figures of inflation views, nor for understanding of the formation of inflation expectations by consumers. We conclude that micro-level inconsistencies do not reduce the reliability of the current EC Consumer Survey dataset. Our results also indicate that inconsistent responses are not important drivers of the inflation overestimation bias displayed in the data.
Using rich panel data including potential output for euro area countries, we analyse budget balance forecasts and their errors. We find that budget balance forecasts are systematically biased and subject to mean reversion (tendency towards more balanced budgets). A robust result is that errors in budget balance nowcasts contribute to errors in budget balance forecasts. In addition, we find that nowcasted macroeconomic conditions can affect over-optimism in budget balance forecasts. Overall, our results emphasize the central role of nowcasting in the EU fiscal framework.
