Testing the Nonlinearity of the Phillips Curve. Implications for Monetary Policy

Abstract

This paper studies the nonlinearity of the Phillips Curve and its implications for monetary policy. To investigate the trade-off between output gap and inflation volatility we used a backward-looking model type. The data for our empirical analysis is obtained from the Area Wide Model (AWM) Database (from 1970 to 2008 for Euro area) and National Institute of Statistics (from 2000 to 2009 for Romania) and has quarterly frequency. The results of econometric tests indicate a significant estimated coefficient of the output gap for Romania, compared with the Eurozone; we find no significant evidence of nonlinearity of the Phillips curve in the European Monetary Union. This suggests that the optimal choice for European Central Bank should be a fixed inflation targeting, while the National Bank of Romania's monetary policy strategy should aim a flexible inflation targeting.

Keywords

• monetary policy
• Phillips curve
• output gap
• inflation
• nonlinearity.