Estimation of Phillips Curve for selected group of European Union countries: a time series perspective

Abstract

The purpose of this work is the study of Phillips curve and its examination across the time series of France, Italy and United-Kingdom. Apart from an empirical analysis it is presented the theoretical review about the evolution of curve over time. The macroeconomic model used for the estimation is expectations-augmented Phillips curve, under the hypothesis that the expectations of inflation are equal to the last year inflation rate. Generally, adaptive-expectations mechanism is applied whose proponent was, among others, Milton Friedman. The model attempts to explain the dynamics of the inflation rate using the one period lagged inflation rate and unemployment rate, thus obtaining the estimate of the model in the Autoregressive Distributed Lag ARDL(1,0) form. The output of the regressions show there is a short-run negative relation between unemployment and inflation rate. Therefore, the model results compatible with inverse trade-off underlying theory of Phillips curve and can be considered as efficient instrument in conduction of the monetary policy. In short-run it is confirmed the existence of the curve for the data took into consideration and model prove to be adequate for the assessment of the inflation performance. In order to get an idea about the final effect of exogenous variable unemployment rate permanent change on inflation rate it is carried out the calculation of long term-coefficients estimate. It is demonstrated that long-term Phillips curve is negative sloping contrary to Friedman’s view who denied its existence in the long-run. Before affirming that we have correct model it is checked for the presence of unit roots. Moreover is performed testing of the residuals of regression. As results evidence there is no threat of spurious regression. However, there is a difference across the country estimates. Verifying the selection criteria all models appear to have satisfactory fitting but the best prove to be Phillips curve related to France.