Has EMU had any effect on anchoring of inflation

expectations? Maritta Paloviita and Matti Viren

Bank of Finland and University of Turku

Basic idea

• The basic idea is an attempt to see whether the Phillips curve has shifted due to the EMU (better anchoring of expectations ). So, what we do is to graph the inflation –unemployment observations (see the word file) and compute the so-called misery indices . The second step has been computation of the dispersion of the respective observations for both EMU and Non-EMU countries using two 15-year-periods.

• This measure is based on a simple program that computes the average distance between all sample observations from each other (each observation is used as the origin in one set of computations and an average of all these computations is reported). Moreover, the variables are weighted within the scale of (0,1) so that the distance of inflation values is not necessarily valued in the same way as the distance of the unemployment observations.

• So, has the EMU been a success story? A comparison between the EMU and Non-EMU countries within the OECD countries gives some idea of relative merits of the monetary union.

Morale

• In regime 1 (well-anchored expectations) the misery index changes only slightly because the economy moves along the short-run Phillips curve, by contrast in all other regimes where the Phillips curve moves outwards/inwards the misery index values change a lot (compare e.g. points A and B).

• This is a simple way of assessing the effects of inflation expectations; the analysis is not conditional to any specific form of the Phillips curve and any specific form of inflation expectations.

inflation

unemployment

LRPC

SRPC

well-anchored regime

Higher inflation exp.

B

A

The data

• The data sample is consists of just two variables • u= the unemployment rate• π = the Inflation rate in terms of the CPI • For the period 1984-1998 & 1999 – 2013 from the OECD data bank

0

1

2

3

4

5

6

2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 5.4

1999

1984Austria

-1

0

1

2

3

4

5

6

7

6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0

1984

1999

Belgium

0

1

2

3

4

5

6

7

8

2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

1984

1999

Finland

0

1

2

3

4

5

6

7

8

7.6 8.0 8.4 8.8 9.2 9.6 10.0 10.4 10.8 11.2

France1984

1999

-1

0

1

2

3

4

5

6

5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5

Germany

1999

1984

-5

0

5

10

15

20

25

6 8 10 12 14 16 18 20 22 24 26 28

1999

1984

Greece

-6

-4

-2

0

2

4

6

8

10

3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

1999

1984

Ireland

0

2

4

6

8

10

12

6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 12.5

1984

1999

Italy

-1

0

1

2

3

4

5

2.4 2.8 3.2 3.6 4.0 4.4 4.8 5.2 5.6 6.0 6.4 6.8 7.2 7.6 8.0 8.4

1984

1999

Netherlands

-5

0

5

10

15

20

25

30

4 5 6 7 8 9 10 11 12 13 14 15 16 17

1984

1999

Portugal

-2

0

2

4

6

8

10

12

8 10 12 14 16 18 20 22 24 26 28

1984

1999

Spain

Inflation unemployment observations for the Euro area countries

0

2

4

6

8

10

4 5 6 7 8 9 10 11

1984

Australia

1999

0

1

2

3

4

5

6

5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5

Canada

1984

1999

0

1

2

3

4

5

6

7

3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0

1984

1999

Denmark

-2

-1

0

1

2

3

4

2.0 2.4 2.8 3.2 3.6 4.0 4.4 4.8 5.2 5.6

1984

1999

Japan

0

1

2

3

4

5

6

7

8

9

1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5

1984

1999

Norway

-4

0

4

8

12

16

3 4 5 6 7 8 9 10 11

1984

1999

New Zealand

-2

0

2

4

6

8

10

12

1 2 3 4 5 6 7 8 9 10

1984

1999

Sweden

0

1

2

3

4

5

6

7

8

4 5 6 7 8 9 10 11 12

1984

1999

United Kingdom

-1

0

1

2

3

4

5

6

3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0

1984

1999

United States

Inflation unemployment observations for the other countries

4

5

6

7

8

9

1985 1990 1995 2000 2005 2010

MISERYAT

4

8

12

16

20

1985 1990 1995 2000 2005 2010

MISERYAU

6

8

10

12

14

16

18

1985 1990 1995 2000 2005 2010

MISERYBE

6

8

10

12

14

16

1985 1990 1995 2000 2005 2010

MISERYCA

4

6

8

10

12

14

16

1985 1990 1995 2000 2005 2010

MISERYDE

8

10

12

14

16

18

20

1985 1990 1995 2000 2005 2010

MISERYFI

8

10

12

14

16

18

1985 1990 1995 2000 2005 2010

MISERYFR

6

8

10

12

14

1985 1990 1995 2000 2005 2010

MISERYGE

10

15

20

25

30

1985 1990 1995 2000 2005 2010

MISERYGR

5

10

15

20

25

1985 1990 1995 2000 2005 2010

MISERYIR

4

8

12

16

20

1985 1990 1995 2000 2005 2010

MISERYIT

2.5

3.0

3.5

4.0

4.5

5.0

5.5

1985 1990 1995 2000 2005 2010

MISERYJP

4

6

8

10

12

1985 1990 1995 2000 2005 2010

MISERYNL

2

4

6

8

10

12

1985 1990 1995 2000 2005 2010

MISERYNO

5

10

15

20

1985 1990 1995 2000 2005 2010

MISERYNZ

0

10

20

30

40

1985 1990 1995 2000 2005 2010

MISERYPT

10

15

20

25

30

1985 1990 1995 2000 2005 2010

MISERYSP

6

8

10

12

14

1985 1990 1995 2000 2005 2010

MISERYSW

4

8

12

16

20

1985 1990 1995 2000 2005 2010

MISERYUK

6

8

10

12

14

1985 1990 1995 2000 2005 2010

MISERYUS

The misery index values

0

4

8

12

16

20

84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

AllEuroOther

Mean values of misery indices

Average Median Euro area 1984-1998 2.93 2.82Euro area 1984-1998 2.45 1.80Other countries 1999-2013 2.09 1.98Other countries 1999-2013 1.20 1.19

Change of the standard deviation of the Misery index 1984-1998/1999-2013

Euro area Other countries

u -.060(5.17

-.061(2.79)

Euro*u .045(2.42)

.055(1.83)

Coefficient of the Euro dummy , the dependent variable ∆∆P

Estimated from ∆2pt = αut + b*Euro*ut + εt) for period 1984-2013

AT

AU

BE

CA

DE

FI

FR

GE

GR

IR

IT

JP

NL

NO

NZ

PT

SP

SW

UK

US

-0.3 -0.25 -0.2 -0.15 -0.1 -0.05 0

Slopes of individual Phillips curves (estimated from ∆2pt = αut + εt) for period 1984-2013.

Phillips curve

Indifference curve

inflation

unemployment

A

How to compute the measure of the dispersion of inflation – unemployment rate observations ?

• Choice of weights for inflation and unemployment • Equal weights • Convex combination of weights from {0,1} interval • The numbers are distance measures; how far are the {unemployment,

inflation} data points from each other

Formula for computing the distanceJust use the Pythagoras theorem • Compute distance between all inflation – unemployment rate

combinations

dp

u

weight 0.5/0.5 gives equal weights for inflation and unemplyment rate

Euro Austria Belgium Finland France Germany Greece Ireland Italy Holland Portugal Spain

1984-1998 1,646 2,440 6,682 2,481 2,395 6,866 3,966 3,030 1,984 8,137 4,172

1999-2013 1,196 1,562 1,997 1,345 2,373 6,046 6,013 2,236 1,726 4,819 6,927

Other Australia Canada Denmark JapanNew Zealand Norway Sweden UK USA

1984-1998 4,078 2,774 2,594 1,504 6,523 3,301 5,852 3,258 1,849

1999-2013 1,591 1,213 1,958 0,986 2,065 1,406 1,908 2,021 2,649

Summary of the results for the 0.5/0.5 case

Austria France Belgium Netherlands Finland Italy Germany Portugal Ireland Greece Spain0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

9.000

1984-19981999-2013

Change of dispersion in the Euro area countries, 0.5/0.5

Japan Canada Norway Australia Sweden Denmark UK New Zealand USA0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

9.000

1984-19981999-2013

Change of dispersion outside the Euro area, 0.5/0.5

Average and median (inside parentheses) changes of dispersion in 1984-1998 vs 1999-2013

Equal 0.5 weights

All weights between 0 and 1

Euro area 0,687(0.794)

0,678(0.547)

Outside Euro 1,770

(1.560)1.712

(1.433)

0,000

0,500

1,000

1,500

2,000

2,500

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Austria

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Belgium

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

3,500

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Germany

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

France

1984-1998

1999-2013

0,0001,0002,0003,0004,0005,0006,0007,0008,0009,000

10,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Greece

1984-1998

1999-2013

0,000

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Finland

1984-1998

1999-2013

0,000

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Ireland

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Italy

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Netherlands

1984-1998

1999-2013

0,000

2,000

4,000

6,000

8,000

10,000

12,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Portugal

1984-1998

1999-2013

0,0001,0002,0003,0004,0005,0006,0007,0008,0009,000

10,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axi

s Ti

tle

Spain

1984-1998

1999-2013

Dispersion with different values of the weight parameter; Euro countries

0,000

1,000

2,000

3,000

4,000

5,000

6,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

Australia

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

3,500

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

Canada

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

Denmark

1984-1998

1999-2013

0,000

0,200

0,400

0,600

0,800

1,000

1,200

1,400

1,600

1,800

2,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

Japan

1984-1998

1999-2013

0,000

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

New Zealand

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

Norway

1984-1998

1999-2013

0,000

1,000

2,000

3,000

4,000

5,000

6,000

7,000

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

Sweden

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

3,500

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

UK

1984-1998

1999-2013

0,000

0,500

1,000

1,500

2,000

2,500

3,000

3,500

0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Axis

Title

USA

1984-1998

1999-2013

Dispersion with different values of the weight parameter; other countries

Conclusions

• Dispersion of inflation and unemployment combinations in the Euro area has decreased indicating better anchoring but it has decreased less than outside the Euro area

• Hence, in this respect the ECB has not outperformed other central banks

Misery index references

• http://mpra.ub.uni-muenchen.de/37493/1/MPRA_paper_37493.pdfhttp://www.cato.org/publications/commentary/measuring-misery-around-world

• http://www.cato.org/publications/commentary/measuring-misery-around-world

•http://www.businessweek.com/stories/1999-02-21/reagan-vs-dot-clinton-whos-the-economic-champ

• http://www.ucema.edu.ar/publicaciones/download/volume10/welsch.pdf

Thank you!