What Determines the Relation between the Output Gap and
Inflation? An International Comparison of Inflation Expectations
and Staggered Wage Adjustment

Masahiro Higo and Sachiko Kuroda Nakada

This paper undertakes a cross-country study on the price-output gap relationship for selected industrialized countries (Japan, the U.S., Germany, the U.K., and Canada). The estimation results show that the price-output gap relationship in these countries can be classified into two categories: (1) a Phillips Curve type (in which the output gap fluctuation affects the inflation rate); and (2) a NAIRU type (in which fluctuations in the output gap affect changes in the inflation rate). In addition, such classifications may vary according to the sample period chosen. During the first half of the observation period (1978-1986), NAIRU-type relations existed in all countries except Japan. During the second half (1987-1997), NAIRU-type relations were observed in the U.S., the U.K., and Canada, while Phillips Curve-type relations were indicated in Japan and Germany. These results lead to the presumption that the price-output gap relationship is influenced by the recent inflation record, which is one of the most important factors that determine the formation mechanism of inflation expectations and the speed of price adjustment.

Key words: Phillips Curve; NAIRU; Expected inflation rate; Price adjustment; Output gap; Inflation; Monetary policy

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