Non-linearities in the Phillips curve: Evidence from the euro area

Dimitris G. Kirikos; Dimitris G. Kirikos

doi:10.3934/QFE.2026002

Quantitative Finance and Economics

2026, Volume 10, Issue 1: 27-40. doi: 10.3934/QFE.2026002

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Research article

Non-linearities in the Phillips curve: Evidence from the euro area

Dimitris G. Kirikos ^{1,2
,
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1.
Department of Accounting and Finance, Hellenic Mediterranean University, Heraklion 71410, Greece
2.
Hellenic Open University, Patras, Greece

Received: 18 June 2025 Revised: 24 October 2025 Accepted: 02 December 2025 Published: 08 January 2026
JEL Codes: E31, E32, E37

Non-linearities in the inflation – output relationship at an aggregate or a sectoral level seems to be a particularly convincing explanation for the observed inflation dynamics in the post-pandemic period. Therefore, in this work, we tested the validity of cross-equation restrictions implied from an aggregate Phillips curve under linear and non-linear stochastic bivariate representations for core inflation and the output gap, using quarterly data from the euro area over the period 2000–2024. A novel feature of our approach was that we did not assume an expectations formation mechanism, but we restricted expectations to be consistent with the aggregate supply and a large information set that included the history of core inflation and the tightness of economic activity. The results provided strong support for the non-linearities argument in explaining the recent quick rise and the subsequent immaculate and rapid fall in inflation. An important policy implication is that the European Central Bank has rightfully not insisted on interest rate hikes, as the inflation episode appears to be mostly a supply side issue.
- Phillips curve,
- Markov switching regimes,
- vector autoregression,
- cross-equation restrictions
Citation: Dimitris G. Kirikos. Non-linearities in the Phillips curve: Evidence from the euro area[J]. Quantitative Finance and Economics, 2026, 10(1): 27-40. doi: 10.3934/QFE.2026002

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Abstract

Non-linearities in the inflation – output relationship at an aggregate or a sectoral level seems to be a particularly convincing explanation for the observed inflation dynamics in the post-pandemic period. Therefore, in this work, we tested the validity of cross-equation restrictions implied from an aggregate Phillips curve under linear and non-linear stochastic bivariate representations for core inflation and the output gap, using quarterly data from the euro area over the period 2000–2024. A novel feature of our approach was that we did not assume an expectations formation mechanism, but we restricted expectations to be consistent with the aggregate supply and a large information set that included the history of core inflation and the tightness of economic activity. The results provided strong support for the non-linearities argument in explaining the recent quick rise and the subsequent immaculate and rapid fall in inflation. An important policy implication is that the European Central Bank has rightfully not insisted on interest rate hikes, as the inflation episode appears to be mostly a supply side issue.

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