Seminario Measure Matters and Identification Even More: Unmasking the New Keynesian Phillips Curve in the Euro Area

Abstract

This paper investigates the structural relationship between economic slack and inflation in the Euro Area from 2001 to 2024, challenging the prevailing narrative of a  disappearing New Keynesian Phillips Curve (NKPC). We address the profound identification challenges arising from the masking effect of optimal monetary policy. Specifically, we demonstrate that when a central bank successfully stabilizes the economy, it effectively masks the underlying aggregate supply curve. By developing a stylized DSGE model, we theoretically show how informational frictions—namely, central bank measurement errors regarding real-time output gaps—paradoxically generate the exogenous demand variation necessary to unveil the true structural link between inflation and slack. Empirically, we implement this analytical framework by leveraging a data-rich factor model to refine the measurement of the output gap, combined with an identification-robust Impulse Response matching estimator. Ultimately, we recover a precise, statistically significant, and asymptotically valid confidence interval for the NKPC slope parameter, tightly bounded around 0.10. These findings firmly confirm that the apparent empirical flat.