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Inside and outside bounds: threshold estimates of the Phillips curve

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  • Michelle L. Barnes
  • Giovanni P. Olivei

Abstract

Over the past 30 years, debates about the usefulness of the Phillips curve for explaining inflation have been ongoing. One of the reasons for the recurring debate about the existence of an inflation and unemployment tradeoff is that there have been several instances when large movements in the unemployment rate have elicited little response in the inflation rate. In principle, these episodes of horizontal movement are consistent with a Phillips curve relationship; they just require the curve to shift in the same direction as the unemployment rate. Econometric representations of the Phillips relationship usually incorporate factors that can cause the Phillips curve to shift over time. However, the literature has not yet provided a test of whether such factors are sufficient to explain the episodes of horizontal movement. ; In this paper, the authors test the explanatory power of a piecewise linear specification of the Phillips relationship against a simple linear specification. The authors find that a piecewise linear specification of the Phillips curve provides a good characterization of inflation dynamics over the past 40 years and that the traditional shifters in the relationships are insufficient to characterize the episodes of horizontal movement. Apparently, the gap between the unemployment rate and the natural rate of unemployment must be outside of some threshold values before triggering a response in inflation. This suggests that monetary policy should aim to drive the unemployment rate lower until the lower limit of the inflation range is reached; however, such a strategy is complicated by the fact that the lower unemployment limit is estimated with uncertainty, leaving the policy implications open to debate.

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Bibliographic Info

Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

Volume (Year): (2003)
Issue (Month): ()
Pages: 3-18

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Handle: RePEc:fip:fedbne:y:2003:p:3-18

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Keywords: Phillips curve;

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  1. Hansen, B.E., 1991. "Inference when a Nuisance Parameter is Not Identified Under the Null Hypothesis," RCER Working Papers 296, University of Rochester - Center for Economic Research (RCER).
  2. Woglom, Geoffrey, 1982. "Underemployment Equilibrium with Rational Expectations," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 89-107, February.
  3. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  4. Jeffrey C. Fuhrer, 1995. "The Phillips curve is alive and well," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 41-56.
  5. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  6. Robert E. Hall, 2003. "Wage Determination and Employment Fluctuations," NBER Working Papers 9967, National Bureau of Economic Research, Inc.
  7. Geoffrey M.B. Tootell, 1994. "Restructuring, the NAIRU, and the Phillips curve," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 31-44.
  8. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
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Cited by:
  1. James H. Stock & Mark W. Watson, 2010. "Modeling inflation after the crisis," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 173-220.
  2. Musso, Alberto & Stracca, Livio & van Dijk, Dick, 2007. "Instability and nonlinearity in the euro area Phillips curve," Working Paper Series 0811, European Central Bank.
  3. Eva M. Köberl, 2011. "Kapazitätsauslastung, Produktionshemmnisse und Preisanpassungen unter dem Mikroskop," KOF Analysen, KOF Swiss Economic Institute, ETH Zurich, vol. 5(4), pages 43-54, December.
  4. Richard Peach & Robert Rich & Anna Cororaton, 2011. "How does slack influence inflation?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 17(June).
  5. Jenny Lye & Ian McDonald, 2008. "The Eisner Puzzle, the Unemployment Threshold and the Range of Equilibria," International Advances in Economic Research, Springer, vol. 14(2), pages 125-141, May.

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