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Inflation expectations and nonlinearities in the Phillips curve

Author

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  • Alexander Doser
  • Ricardo Nunes
  • Nikhil Rao
  • Viacheslav Sheremirov

Abstract

This paper shows that a simple form of nonlinearity in the Phillips curve can explain why, following the Great Recession, inflation did not decrease as much as predicted by linear Phillips curves, a phenomenon known as the missing disinflation. We estimate a piecewise-linear specification and document that the data favor a model with two regions, with the response of inflation to an increase in unemployment slower in the region where unemployment is already high. Nonlinearities remain important, even when we account for other factors proposed in the literature, such as consumer expectations of inflation or financial frictions. However, studying a range of specifications with different measures of inflation and economic activity, we conclude that, in most cases, consumer expectations are more robust than nonlinearities. We find that the role of consumer expectations was especially important in the 1970s and ?80s, during a turbulent rise in inflation followed by the Volcker disinflation; the nonlinearities make disinflation more problematic and require the inflation expectations process to be more forward-looking during this period, thereby putting a larger weight on survey expectations. We conclude that a nonlinear Phillips curve with forward-looking survey expectations can be a useful tool to understand inflation dynamics during episodes of rapid disinflation and persistent inflation.

Suggested Citation

  • Alexander Doser & Ricardo Nunes & Nikhil Rao & Viacheslav Sheremirov, 2017. "Inflation expectations and nonlinearities in the Phillips curve," Working Papers 17-11, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:17-11
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    Cited by:

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    2. Luís Aguiar-Conraria & Manuel M. F. Martins & Maria Joana Soares, 2019. "The Phillips Curve at 60: time for time and frequency," NIPE Working Papers 04/2019, NIPE - Universidade do Minho.
    3. Sitikantha Pattanaik & Silu Muduli & Soumyajit Ray, 2020. "Inflation expectations of households: do they influence wage-price dynamics in India?," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 13(3), pages 244-263, September.
    4. Ferri, Piero & Cristini, Annalisa & Tramontana, Fabio, 2023. "Meta-models of the Phillips curve and income distribution," Journal of Economic Behavior & Organization, Elsevier, vol. 213(C), pages 215-232.
    5. Aguiar-Conraria, Luís & Martins, Manuel M.F. & Soares, Maria Joana, 2023. "The Phillips curve at 65: Time for time and frequency," Journal of Economic Dynamics and Control, Elsevier, vol. 151(C).
    6. Lazopoulos, Ioannis & Gabriel, Vasco, 2019. "Policy mandates and institutional architecture," Journal of Banking & Finance, Elsevier, vol. 100(C), pages 122-134.
    7. Peter Hooper & Frederic S. Mishkin & Amir Sufi, 2019. "Prospects for Inflation in a High Pressure Economy: Is the Phillips Curve Dead or is It Just Hibernating?," NBER Working Papers 25792, National Bureau of Economic Research, Inc.
    8. Andrew Keinsley & Sandeep Kumar Rangaraju, 2021. "The Nonlinear Unemployment-Inflation Relationship and the Factors That Define It," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 47(3), pages 354-377, June.
    9. Philippe Goulet Coulombe, 2021. "The Macroeconomy as a Random Forest," Working Papers 21-05, Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management.
    10. Hooper, Peter & Mishkin, Frederic S. & Sufi, Amir, 2020. "Prospects for inflation in a high pressure economy: Is the Phillips curve dead or is it just hibernating?," Research in Economics, Elsevier, vol. 74(1), pages 26-62.
    11. Harding, Martín & Lindé, Jesper & Trabandt, Mathias, 2022. "Resolving the missing deflation puzzle," Journal of Monetary Economics, Elsevier, vol. 126(C), pages 15-34.
    12. Luengo-Prado, María José & Rao, Nikhil & Sheremirov, Viacheslav, 2018. "Sectoral inflation and the Phillips curve: What has changed since the Great Recession?," Economics Letters, Elsevier, vol. 172(C), pages 63-68.
    13. repec:zbw:bofrdp:2019_012 is not listed on IDEAS
    14. Luís Aguiar-Conraria & Manuel M. F. Martins & Maria Joana Soares, 2019. "The Phillips Curve at 60: time for time and frequency," CEF.UP Working Papers 1902, Universidade do Porto, Faculdade de Economia do Porto.
    15. Anat Bracha & Jenny Tang, 2019. "Inflation Thresholds and Inattention," Working Papers 19-14, Federal Reserve Bank of Boston.

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    Keywords

    inflation expectations; Phillips curve; Volcker disinflation;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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