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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
Contact details of provider: Postal: Boston College, 140 Commonwealth Avenue, Chestnut Hill MA 02467 USA
Phone: 617-552-3670
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Web page: http://fmwww.bc.edu/EC/
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  1. Mankiw, N Gregory & Reis, Ricardo, 2010. "Imperfect Information and Aggregate supply," CEPR Discussion Papers 7711, C.E.P.R. Discussion Papers.
  2. N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2003. "Disagreement about Inflation Expectations," Harvard Institute of Economic Research Working Papers 2011, Harvard - Institute of Economic Research.
  3. Laurence Ball & N. Gregory Mankiw & David Romer, 1988. "The New Keynsesian Economics and the Output-Inflation Trade-off," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 1-82.
  4. repec:fip:fedgsq:y:2002:i:nov21 is not listed on IDEAS
  5. Douglas O. Staiger & James H. Stock & Mark W. Watson, 1997. "How Precise Are Estimates of the Natural Rate of Unemployment?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 195-246 National Bureau of Economic Research, Inc.
  6. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  7. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  8. N. Gregory Mankiw, 2000. "The Inexorable and Mysterious Tradeoff Between Inflation and Unemployment," Harvard Institute of Economic Research Working Papers 1905, Harvard - Institute of Economic Research.
  9. Mazumder, Sandeep, 2010. "The new Keynesian Phillips curve and the cyclicality of marginal cost," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 747-765, September.
  10. James H. Stock & Mark W. Watson, 2008. "Phillips Curve Inflation Forecasts," NBER Working Papers 14322, National Bureau of Economic Research, Inc.
  11. Robert B. Barsky, 1986. "The Fisher Hypothesis and the Forecastability and Persistence of Inflation," NBER Working Papers 1927, National Bureau of Economic Research, Inc.
  12. John C. Williams, 2006. "Inflation persistence in an era of well-anchored inflation expectations," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue oct13.
  13. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1295-1328, November.
  14. Robert J. Gordon, 1988. "U.S. Inflation, Labor's Share, and the Natural Rate of Unemployment," NBER Working Papers 2585, National Bureau of Economic Research, Inc.
  15. Laurence Ball & Sandeep Mazumder, 2011. "Inflation Dynamics and the Great Recession," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(1 (Spring), pages 337-405.
  16. Mazumder, Sandeep, 2011. "Cost-based Phillips Curve forecasts of inflation," Journal of Macroeconomics, Elsevier, vol. 33(4), pages 553-567.
  17. repec:fip:fedgsq:y:2008:x:60 is not listed on IDEAS
  18. 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.
  19. Robert G. Murphy, 1999. "What's Behind the Decline in the NAIRU?," Boston College Working Papers in Economics 435, Boston College Department of Economics.
  20. Ben S. Bernanke, 2002. "Deflation: making sure "it" doesn't happen here," Speech 530, Board of Governors of the Federal Reserve System (U.S.).
  21. Robert G. Murphy, 1998. "Accounting for the Recent Decline in the NAIRU," Boston College Working Papers in Economics 414, Boston College Department of Economics.
  22. Ricardo Reis, 2005. "Inattentive Producers," 2005 Meeting Papers 290, Society for Economic Dynamics.
  23. N. Gregory Mankiw & Ricardo Reis, 2007. "Sticky Information in General Equilibrium," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 603-613, 04-05.
  24. 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.
  25. Ben S. Bernanke, 2010. "Opening remarks: the economic outlook and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 1-16.
  26. 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.
  27. 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, March.
  28. John C. Williams, 2010. "Sailing into headwinds: the uncertain outlook for the U.S. economy," Speech 85, Federal Reserve Bank of San Francisco.
  29. Robert J. Gordon, 1981. "Inflation, Flexible Exchange Rates, and the Natural Rate of Unemployment," NBER Working Papers 0708, National Bureau of Economic Research, Inc.
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