This paper presents the New Keynesian Phillips Curve (NKPC) -based framework for analysing euro area inflation outlook. Our NKPC specification, that relies on market- and survey-based inflation expectations, explains well euro area inflation dynamics. Its forecasting performance is also comparable to the performance of the ECB's official forecasts in both short- and long-horizons. Overall, the NKPC is a useful tool for monitoring euro area inflation outlook. Thanks to its fast and light updating procedure it provides almost real-time information on inflation outlook.

We prove that under the most typical circumstances optimal emission prices are procyclical, i.e., prices should be lower during recessions. The procyclicality is more likely when emissions propagate very slowly into environmental damage. A prime example of such process is CO2 emissions. We show that carbon prices should be closely linked to the fluctuations of the marginal utility of consumption, which implies relatively modest magnitude of carbon price fluctuations. Our findings imply that climate policies should focus on setting the carbon price to the optimal growth path level and give carbon price fluctuations only a secondary role. Opposite to the carbon price, the cyclicality of optimal emissions depends on the production technology in the energy sector, and may become countercyclical in future if the technology mix becomes less fossil dependent.

According to a model-based assessment by the Bank of Finland, tariff increases currently in place will slow global GDP growth by around 0.7 of a percentage point. The trade dispute has already diminished trade flows between the United States and China. The growth of uncertainty has been reflected in investment sentiment, and manufacturing purchasing manager indices have fallen globally. News updates on the current negotiation situation have caused volatility in share prices and securities market risk premia, but significant disruptions on the financial markets have so far been avoided. In an adverse scenario calculated by the Bank of Finland, further escalation of the trade war and subsequent widespread disruptions to the financial markets would slow global GDP growth by a further two percentage points.

We estimate the long-term natural rate of interest for the euro area with two specifications of a simple semi-structural macroeconomic model. The estimates provide competing interpretations for the euro area’s current economic environment of weak growth, subdued inflation and exceptionally low nominal interest rates. In our first estimation, the current state of economy is attributed to persistent, recurring negative shocks to the output gap that restrain growth even when expansionary monetary policies are applied. The second estimation suggests that a large drop in the natural rate of interest is the problem, because, even with interest rates held close to zero, policy actions have not been able to revive the economy after major shocks in 2008, 2012 and 2016. As both views may explain some of the observed trends, the task of teasing out the drivers of current conditions and future trends is non-trivial. Nevertheless, policymakers should pay attention to both stories as they have quite different endings.

This section reviews recent inflation developments and discusses the short-term outlook for inflation using a simple open-economy New Keynesian Phillips curve (NKPC). We first estimate the NKPC with time-varying parameters to analyse whether any longer-term changes could be detected in the relationship between inflation and its determinants. We then provide short-term inflation projections for the euro area and discuss the level of uncertainty surrounding these projections. Our results suggest that the sensitivity of euroarea inflation to the output gap may have increased since 2007. It remains unclear, however, whether this implies a structural change in the relationship between inflation and output. Looking ahead, projections obtained using the NKPC support the view that we are going to see a prolonged period of subdued inflation in the euro area. Annual inflation is projected to slowly start accelerating only towards the end of 2014. Based on the historical variance of the parameters of the NKPC, our assessment of the uncertainty surrounding the projection suggests that the probability of euro-area inflation turning negative over the next two years is small, while the probability of inflation rising to significantly above 2% is close to negligible.

There have been significant fluctuations in the euro exchange rate since the start of the monetary union. This section assesses Member StatesA­ different degrees of vulnerability to changes in the exchange rate. It looks in particular at possible differences in the pass-through of the nominal exchange rate into import and consumer prices, and at differences in the price elasticity of export volumes. Overall, empirical results show a higher sensitivity of Spain's inflation, and export price elasticities, that are significantly higher in Italy, Portugal, Spain, Austria and France. However, in terms of overall impact on activity, differences in export elasticities tend to be offset, at least in part, by differences in trade openness and in integration in global value chains.

This paper analyzes euro area and U.S. inflation dynamics since the beginning of the 1990s by estimating New Keynesian hybrid Phillips curves with time-varying parameters. We measure inflation expectations by subjective forecasts from Consensus Economics survey and so do not assume rational expectations. Both rolling regressions and state-space models are employed. The results indicate that in both economic areas the inflation dynamics have steadily become more forward-looking over time. We also provide evidence that the impact of the output gap on inflation has increased in recent years. Overall, diminished inflation persistence emphasizes the role of credible monetary policy in inflation dynamics.

This paper studies the cyclical properties of optimal emission taxes and emissions using a real business cycle model with a stock pollutant. We derive conditions for the procyclicality of optimal emission tax and show that the tax is in typical conditions procyclical. The possibility of a countercyclical behavior of the emission tax increases if 1) the pollution is short-lived and the emission transfer into environmental damages rapidly 2) emissions are countercyclical, 3) marginal damages are strongly increasing and 4), in disutility case, the marginal utility of consumption increases with the increase in the intensity of the harmful environmental process. In the climate change context we show that the optimal carbon tax is procyclical irrespectively on the production technology. Instead, the technology is a key determinant of the cyclicality of the emissions. The optimal carbon tax correlates almost fully with the consumption and as a rule-of thumb, it could be indexed to the consumption level of the economy. The relative scale of tax deviations relative to the consumption deviations is determined by the inverse of the intertemporal elasticity of substitution. Comparison between the optimal emission tax and an optimally set constant emission tax shows that the constant tax leads to very slightly higher emissions but the general economic effects are next to negligible.