No 108. An Expectations-Augmented Phillips Curve in an Open Economy

by Kerstin Hallsten

Abstract

In this paper an expectations-augmented Phillips curve realtion in an open economy is derived and estimated. As in Rotemberg's (1982) model firms are assumed to face quadratic price adjustment costs. In addition, second-order costs of changing prices are not included. Consequently the derived infaltion equstion incorporates not only a forward-looking component but also a backward-looking element. The model is then estimated on Swedish data. The results from this estimation shed light in the importance of inflation expectations for the development of current inflation in comparison to past inflation rates. This is, for example, of great importance to a central bank trying to achive an inflationtarget. A common characteristic of inflation targeting models is that with a lower degree of persistence in inflation, a credible central bank can achive its inflation target with relatively little loss in output.