A Scientific Inquiry on the Estimation of the Phillips Curve in the Baltic Region

Abstract

Countries in the European Union (EU) have experienced a number of economic problems in the aftermath of the Eurozone crisis, including high unemployment and inflation. However, there is still a lack of systematic analyses of these issues, especially in the context of the new EU member countries. This study aims to address this research gap. It examines an important topic in applied macroeconomics research-the Phillips curve-and chooses three Baltic countries, namely, Estonia, Latvia and Lithuania, as case studies. In other words, the main objective of this paper is to revisit the debate on the inflation-unemployment trade-off by estimating the new Keynesian Phillips curve (NKPC) in the Baltic region over the period of 1995-2013. The analysis was based on the generalized method of moments (GMM) procedure suggested by Gali and Gertler (1999). The novelty of the present study is that it applied the Gali-Gertler method to examine the trade-off relationship between inflation and unemployment in the Baltic countries. This study yielded some important findings. Firstly, it was found that inflation dynamics in the Baltic countries was largely determined by forward-looking behaviour, which means that firms located in the region had forward-looking price setting tendency and they paid due attention to the expected level of inflation. Secondly, the inflation dynamics did not seem to be determined by backward tendency and the firms in the region did not have backward price setting tendency. Thirdly, no significant trade-off relationship was detected between inflation rate and marginal cost. In other words, there was no significant negative association between the inflation rate and marginal cost in the Baltic countries.

Asymmetries in effects of domestic inflation drivers in the Baltic States: a Phillips curve-based nonlinear ARDL approach

“…Similar findings are documented in Virbickas (2012) for Lithuania. Furuoka (2016) analyse the validity of the New Keynesian Phillips curve in the Baltic States. According to that study, the inflation dynamics is mainly determined by forward-looking inflation expectations, whereas marginal costs do not expose a significant impact on the inflation rate.…”

“…Although advocated by numerous researchers (e.g. Chin, 2019;Furuoka, 2016;Galí et al, 2001;Tatierská, 2010), the application of labour share and unit labour costs as a proxy for marginal costs became increasingly problematic (Coibon & Gorodnichenko, 2015;Karabarbounis & Neiman, 2013;King & Watson, 2012;Lindé, 2005;Rudd & Whelan, 2005). Accordingly, we employ the Phillips curve specification with an output gap and, alternatively, the unemployment gap, as measures of economic activity.…”

“…Accordingly, changes in the marginal cost ultimately causing changes in product prices. Numerous studies confirm this statement, most often using unit labour costs as an approximation for real marginal costs (for example, Alexová, 2012;Furuoka, 2016;Galí, 2000;Tatierská, 2010). Yet, there are also studies that dispute the importance of the labour share and unit labour costs for explaining the dynamics of inflation, arguing these are not a credible measure of the real marginal costs (Karabarbounis & Neiman, 2013;King & Watson, 2012;Peneva & Rudd, 2017).…”