The New Keynesian Phillips Curve for Austria – An Extension for the Open Economy

Following the empirical breakdown of the traditional Phillips curve relationship, the baseline New Keynesian Phillips Curve (NKPC) theory was formulated in the 1990s. Unlike the traditional Phillips curve, it derives from a theoretical model that is based on microeconomic principles. It expresses current inflation as a function of expected future inflation, past inflation and a measure of firms’ marginal cost. The NKPC serves to estimate the model’s structural parameters that capture price-setting behavior in an economy. This study estimates the NKPC using Austrian data. As Austria is a fairly open economy and the NKPC was initially formulated for a closed economy, the theoretical model is extended to include open-economy aspects and is then estimated in various specifications. The extended NKPC proves to explain inflation developments in Austria since 1980 quite accurately. The estimation of the structural parameters shows that around 30% of all Austrian firms change their prices every quarter, indicating that overall, prices are constant for an average of roughly ten months. Moreover, between 30% and 50% of all firms follow a backward-looking rule of thumb in setting their prices. Compared to the other euro area countries, this price duration represents an average, whereas the degree of backwardlooking behavior in price setting is above average. However, the NKPC is not found to be as suitable for forecasting purposes as time-series models, as none of the inflation forecasts based on the NKPC model was able to outperform a naive forecast (unchanged inflation rate over the forecast horizon).