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Explaining Inflation in the Aftermath of the Great Recession

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  • Robert G. Murphy

    ()
    (Boston College)

Abstract

This paper considers whether the Phillips curve can explain the recent behavior of inflation in the United States. Standard formulations of the model predict that the ongoing large shortfall in economic activity relative to full employment should have led to deflation over the past several years. I confirm previous findings that the slope of the Phillips curve has varied over time and probably is lower today than it was several decades ago. This implies that estimates using historical data will overstate the responsiveness of inflation to present-day economic conditions. I modify the traditional Phillips curve to explicitly account for time variation in its slope and show how this modified model can explain the recent behavior of inflation without relying on anchored expectations. Specifically, I explore reasons why the slope might vary over time, focusing on implications of the sticky-price and sticky-information approaches to price adjustment. These implications suggest that the inflation environment and uncertainty about regional economic conditions should influence the slope of the Phillips curve. I introduce proxies to account for these effects and find that a Phillips curve modified to allow its slope to vary with uncertainty about regional economic conditions can best explain the recent path of inflation.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 823.

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Date of creation: 02 Jul 2013
Date of revision: 07 Jan 2014
Handle: RePEc:boc:bocoec:823

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Keywords: Inflation; Phillips curve; Great Recession; Sticky Information; Sticky Prices;

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References

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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  2. Mankiw, N Gregory & Reis, Ricardo, 2010. "Imperfect Information and Aggregate supply," CEPR Discussion Papers 7711, C.E.P.R. Discussion Papers.
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Cited by:
  1. Robert G. Murphy & Adam Rohde, 2014. "Rational Bias in Inflation Expectations," Boston College Working Papers in Economics 857, Boston College Department of Economics.
  2. Christian Friedrich, 2014. "Global Inflation Dynamics in the Post-Crisis Period: What Explains the Twin Puzzle?," Working Papers 14-36, Bank of Canada.

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