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Explaining Inflation in the Aftermath of the Great Recession

  • Robert G. Murphy

    ()

    (Boston College)

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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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: 18 Oct 2014
Publication status: published, Journal of Macroeconomics, 2014, 40, 228-244
Handle: RePEc:boc:bocoec:823
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  32. 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.
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