| By: |
Schleer, Frauke;
Kappler, Marcus |
| Abstract: |
The path of output prior to the financial and economic crisis turned out to be
not sustainable and lower than previously estimated in some European crisis
countries. Specifically, the output gaps have been underestimated (and
inversely potential output overestimated) before the recent crisis. It is fair
to say that the employed estimation techniques failed to provide valid
real-time assessments of the state of the credit boom driven euro area
economies. One reason for this may be the breakdown of the Phillips curve
relationship during the last years. Against this backdrop, we comprehensively
analyse the validity of the Phillips curve for five European countries with a
focus on the recent crisis. We find that a mostly insignificant relation
between inflation and the output gap or unemployment gap, which questions the
adequacy of the Phillips curve to identify the sustainable level of output in
an economy. The credit-driven boom in crisis countries has made clear that
(disadvantageous) financial markets conditions may result in structural and
long-term real economic distortions that are not yet taken into account in
conventional methods for the estimation of potential output and the output
gap. Since both, potential output and output gaps, are a key notion in
policymaking, incorporating financial factors could improve the reliability of
the estimates. Our results point in this direction. |
| Keywords: |
Phillips curve,potential output,output gap,financial cycle,credit cycle,NAIRU |
| JEL: |
E32 E44 E60 |
| Date: |
2014 |
| URL: |
http://d.repec.org/n?u=RePEc:zbw:zewdip:14067&r=hpe |