Linking Excessive Disinflation and Output Movements in an Emerging, Small Open Economy -- A Hybrid New Keynesian Phillips Curve Perspective

Excessive disinflation and the flattening of the Phillips curve are recently popular phenomena in many advanced economies. In the environment of low inflation, the fading relationship between the price dynamics and the adjustments in the domestic real activity is vigorously investigated for highly developed economies. Still little evidence has been presented for emerging, small open economies. In this paper I address this issue by investigating the behavior of the Phillips curve for Poland. In particular, I aim at answering the question whether a Phillips curve flattening or a steepening can be observed during the recent abrupt disinflation. The outstanding problem of considerable uncertainty accompanying the model specification is accounted for by estimating a substantial number of regressions and exploring the cross-section properties of the hybrid NKPC parameters. The results advocate that a statistically significant relationship between inflation and the domestic real activity developments persists. However, in the recently observed disinflation period the Phillips curve tends to flatten as the inflation's sensitivity with respect to changes in economic slack diminishes. That notwithstanding, the impact of external factors rises significantly. Conditional ex-post forecasts suggest that while only a limited number of Phillips curve specifications manage to explain the disinflation process in Poland, employing unemployment gap or real GDP as economic slack proxies delivers the most accurate inflation forecasts