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Understanding the inflation–output relationship across business cycle phases

Author

Listed:
  • De Santis, Roberto A.
  • Cardamone, Dario

Abstract

We examine the state dependence of monetary policy transmission and the parameters of the Phillips curve, dynamic IS equation, and Taylor rule across four regimes defined by joint deviations of inflation from the Federal Reserve’s target and output from potential. The analysis uncovers important regime-specific asymmetries. The Taylor principle holds across all four regimes. The systematic policy response to the output gap weakens when inflation is below target but output remains above potential, whereas the response to inflation is broadly similar across regimes. The size of monetary policy shocks is significantly larger when inflation exceeds its target. The Phillips curve steepens when inflation exceeds target and output is above potential, while output sensitivity to interest rate changes declines under high inflation and economic slack. This explains why monetary policy shocks are significantly larger in inflationary booms, but transmission becomes less effective when elevated inflation coincides with economic slack. JEL Classification: C32, E52

Suggested Citation

  • De Santis, Roberto A. & Cardamone, Dario, 2026. "Understanding the inflation–output relationship across business cycle phases," Working Paper Series 3175, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20263175
    Note: 185689
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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