Inflation dynamics in Finland 1990Q1-2012Q1

Abstract

The objective of this thesis is to study whether inflation dynamics in Finland can be described using the New Keynesian Phillips curve (NKPC) over the period 1990Q1-2012Q1. The NKPC explains current inflation with forward-looking inflation expectations and current real marginal cost. The assumption of rational expectations is relaxed in this thesis and both Consensus Economics and Statistics Finland's survey data are used as proxies for inflation expectations. Since these expectations are expectations for consumer prices, inflation is measured with annual change in the Consumer Price Index. Output gap is used as a proxy for real marginal cost. The NKPC is estimated with both Ordinary Least Squares (OLS) and Generalised Method of Moments (GMM). The variables are also analysed using the frequency domain method, which gives information on the dynamics of both correlations and lead-lag relationships of variables at different frequencies. Estimations in this thesis show that once the rational expectations hypothesis is relaxed and survey-based inflation expectations are used, inflation in Finland can be explained with the New Keynesian Phillips curve over the period 1990Q1-2012Q1. The analysis of variables in this thesis shows that the dynamics of variables used in the NKPC estimations varied at different frequencies.