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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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Related research

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

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  1. Sandeep Mazumder, 2008. "The New Keynesian Phillips Curve and the Cyclicality of Marginal Cost," Economics Working Paper Archive 545, The Johns Hopkins University,Department of Economics.
  2. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Harvard Institute of Economic Research Working Papers 1922, Harvard - Institute of Economic Research.
  3. James H. Stock & Mark W. Watson, 2008. "Phillips Curve Inflation Forecasts," NBER Working Papers 14322, National Bureau of Economic Research, Inc.
  4. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  5. Mankiw, N. Gregory & Reis, Ricardo & Wolfers, Justin, 2003. "Disagreement about Inflation Expectations," Research Papers 1807, Stanford University, Graduate School of Business.
  6. Robert B. Barsky, 1986. "The Fisher Hypothesis and the Forecastability and Persistence of Inflation," NBER Working Papers 1927, National Bureau of Economic Research, Inc.
  7. Sandeep Mazumder & Laurence M. Ball, 2011. "Inflation Dynamics and the Great Recession," IMF Working Papers 11/121, International Monetary Fund.
  8. 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.
  9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  10. Robert G. Murphy, 1999. "What's Behind the Decline in the NAIRU?," Boston College Working Papers in Economics 435, Boston College Department of Economics.
  11. Robert G. Murphy, 1998. "Accounting for the Recent Decline in the NAIRU," Boston College Working Papers in Economics 414, Boston College Department of Economics.
  12. Murphy, Robert G., 1986. "The expectations theory of the term structure: Evidence from inflation forecasts," Journal of Macroeconomics, Elsevier, vol. 8(4), pages 423-434.
  13. Mazumder, Sandeep, 2011. "Cost-based Phillips Curve forecasts of inflation," Journal of Macroeconomics, Elsevier, vol. 33(4), pages 553-567.
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