Expectation formation and the Phillips curve revisited

Abstract

Abstract This paper studies expectation formation of professional forecasters in the context of the Phillips curve. We assess whether professionals form their expectations regarding inflation and unemployment consistent with the Phillips curve based on individual forecast data taken from the ECB Survey of Professional Forecasters. We consider expectations over different horizons and do not restrict the analysis to point forecasts but we also take the information inherent in density forecasts into account. We explicitly consider the role of anchoring of inflation expectations as potential source of nonlinearity, and we also assess whether the Phillips curve relation translates to a link between uncertainty regarding inflation and unemployment. Our findings show that professionals tend to build their expectations in line with the Phillips curve but this is only observed for expectations made for shorter horizons. For longer horizons, the Phillips curve connection is much weaker. This relationship also depends on the degree of anchoring and results in a connection between uncertainty regarding future inflation and unemployment.