Abstract

We use Bayesian techniques to estimate bivariate VAR models for Swedish unemployment rate and inflation. Employing quarterly data from 1995Q1 to 2018Q3 and new tools for model selection, we compare models with time-varying parameters and/or stochastic volatility to specifications with constant parameters and/or covariance matrix. The evidence in favour of a stable dynamic relationship between the unemployment rate and inflation is mixed. Model selection based on marginal likelihood calculations indicates that the relation is time varying, whereas the use of the deviance information criterion suggests that it is constant over time; we do, however, note consistent evidence in favour of stochastic volatility. An out-of-sample forecast exercise is also conducted, but similarly provides mixed evidence regarding which model to favour. Importantly though, even if time-varying parameters are allowed for, our results do not suggest that the Phillips curve has been flatter in more recent years. This finding thereby questions the explanation that a flatter Phillips curve is the cause of the low inflation that Sweden has experienced in recent year.

Highlights

  • Inflation in Sweden has been stubbornly low over the last years

  • We find results that echo our previous findings: Marginal likelihoods favour the model with time-varying parameters and stochastic volatility, and the deviance information criterion (DIC) selects the model with constant parameters and stochastic volatility

  • Conducting model selection using new methods, we found mixed evidence in favour a stable relationship between inflation and the unemployment rate

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Summary

Introduction

Inflation in Sweden has been stubbornly low over the last years. This development is similar to that in several other inflation-targeting countries where inflation has been moderate, and increasing slowly, despite historically low policy-interest rates and developments in the real economy which many argue should have generated a stronger inflationary pressure; see, for example, Jansson (2017) and Yellen (2017). One explanation for the low inflation which has been put forward is that the Phillips curve has become flatter, for example, due to globalisation and digitalisation.. In this paper we contribute to the discussion regarding the properties of the Phillips curve by providing evidence based on Swedish data. We estimate models with time-varying parameters and/or stochastic volatility and compare these models to specifications with constant parameters and/or covariance matrix. Relying on new tools for model selection developed by Chan and Eisenstat (2018), we formally assess which model is preferred by the data. This constitutes a step forward relative to the vast majority of previous related research. Since model selection is a non-trivial issue when models with timevarying parameters and stochastic volatility are involved, it has often been assumed that it is reasonable to employ a model with such features. In this paper we instead evaluate this assumption using marginal likelihoods and the deviance information criterion (DIC) and can provide statistical evidence on the stability of the Swedish Phillips curve

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