Time variation, asymmetry and threshold effects in Malta's Phillips curve

Abstract

This paper estimates a Phillips curve for Malta using data since the 1960s and presents ev- idence that the relationship has attened over time, implying that the link between in ation and economic activity has weakened. Further analysis nds that this phenomenon was driven by downward price stickiness, whereby the responsiveness of price in ation is limited during eco- nomic slowdowns; however the Phillips curve was and remains alive during economic booms. Other threshold e ects are also present; with only statistically large shocks having an e ect dur- ing a boom. This study also nds a strong increase in the importance of import price shocks in driving consumer price in ation in the Maltese economy. The estimated variance of shocks to in ation was high in the 1980s, but has fallen greatly since then. Estimates of the Wage Phillips curve show a strong link between economic activity and wage growth. This channel operates mainly through slower wage growth during recessions, as periods of strong economic growth were not associated with faster wage growth. Similar threshold e ects also exist; this channel only operates when economic slack is high. A number of structural changes in the Maltese economy, notably EU accession and favourable labour market developments may explain the stability in wage growth and some of the findings.