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Inside and Outside Bounds: Threshold Estimates of the Phillips Curve

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  • Giovanni P. Olivei
  • Michelle L. Barnes

Abstract

There have been several instances over the past 40 years when large movements in the unemployment rate have elicited little response in the inflation rate. Such instances, while casting doubt on the tradeoff implied by the linear Phillips curve, are also associated with large inflation forecasting errors. In principle, these movements 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 double threshold specification of the Phillips relationship against a simple linear specification, and compare dynamic and static out of sample forecasts of inflation across linear and double threshold specifications of the Phillips curve. The authors find that traditional shifters in the relationships are insufficient for characterizing the periods of horizontal movement, and that a double threshold specification makes significant improvements in the static and dynamic out of sample inflation forecasting performance of the Phillips curv

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 Australasian Meetings with number 295.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:ausm04:295

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Keywords: Phillips Curve; Threshold Models; Inflation Forecasting;

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  1. Woglom, Geoffrey, 1982. "Underemployment Equilibrium with Rational Expectations," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 89-107, February.
  2. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, vol. 64(2), pages 413-30, March.
  3. Robert E. Hall, 2003. "Wage Determination and Employment Fluctuations," NBER Working Papers 9967, National Bureau of Economic Research, Inc.
  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. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608.
  7. 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.
  8. 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.
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Cited by:
  1. Alberto Musso & Livio Stracca & Dick van Dijk, 2007. "Instability and nonlinearity in the Euro area Phillips curve," Working Paper Series 811, European Central Bank.
  2. 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.
  3. James H. Stock & Mark W. Watson, 2010. "Modeling Inflation After the Crisis," NBER Working Papers 16488, National Bureau of Economic Research, Inc.
  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, issue June.

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