Catch Me if You Can – the Phillips Curve : A Structural Vector Autoregressive Analysis of the Flattening Phillips Curve Hypothesis for Norway over the Past Fifty Years

Abstract

This thesis examines if the Phillips curve in Norway has flattened over the past fifty years, and what implications this could have for the conduct of monetary policy. Several research papers have estimated that the slope of the Phillips curve for many advanced economies have flattened over time. However, the research is limited in the case of the Norwegian economy. The starting point of the analysis is estimation of various correlation coefficients. Building on the International Monetary Fund (2013), Blanchard et al. (2015) and Blanchard (2016), the Phillips curve relation is thereafter modelled using Ordinary Least Squares regressions (OLS) and rolling regressions. Building on Neri (2004) and Bjørnland (2009), Structural Vector Autoregression (SVAR) models with short-run restrictions and Cholesky decompositions are then applied. The correlation coefficient, regressions and impulse responses are used to evaluate potential changes in the slope coefficient of the Phillips curve and the behavior of inflation expectations. Consistent with prior research, the empirical results indicate that the slope of the Phillips curve in Norway has decreased in the period 1982 – 2012. The empirical results involving the last decade are more ambiguous. Rolling regression results considering the behavior of inflation expectations suggest that expectations have become more firmly anchored since Norges Bank became independent in 1985. Stable inflation expectations after 1985 further indicate stable inflation dynamics induced by a flatter aggregate supply curve. Impulse responses of inflation suggest a reduced responsiveness of inflation to demand shocks. The real economy remains reactive to the shocks in before and after 1992. The findings implicate a weakening of the demand channel to inflation in the inflation targeting monetary policy model. This implies that it has become harder to control the rate of inflation through changes in the real economy. Subsequently, this indicate that larger variations in the real economy is necessary to bring inflation back to target.