The Condemned Live Longer – New Evidence of the New Keynesian Phillips Curve in Central and Eastern Europe

Abstract

We study inflation dynamics in emerging, small open economies of Central and Eastern Europe (CEE) and find new empirical evidence of the existence of the New Keynesian Phillips Curve (NKPC). Acknowledging specification uncertainty, a comprehensive set of alternative proxies for the NKPC’s components is assessed. Our results indicate the superiority of labor market measures for economic slack, support the use of survey inflation expectations and confirm the NKPC’s open economy version. Further, we investigate the stability of the NKPC over time, performing Bayesian inference in a time-varying parameter stochastic volatility version of the model. The results do not suggest the NKPC to have flattened in CEE challenging recent evidence in advanced economies. Inflationary dynamics have not decoupled from the state of the domestic economy. Therefore, a balanced approach to monetary policy which neither neglects the domestic nor external drivers of inflation and focuses on anchoring inflation expectations is well justified.