The Phillips Curve is Alive and Well: Inflation and the NAIRU During the Slow Recovery
The Phillips Curve (hereafter PC) is widely viewed as dead, destined to the mortuary scrapyard of discarded economic ideas. The coroner's evidence consists of the small standard deviation of the core inflation rate in the past two decades despite substantial volatility of the unemployment rate, and in particular the common tendency of PC inflation equations to predict ever greater amounts of negative inflation (i.e., deflation) over the years of labor-market slack since 2008, sometimes called "the case of the missing deflation". The apparent failure of the PC deprives the Fed of a means of estimating the natural rate of unemployment (or NAIRU), and thus the Fed is steering the economy in a fog with no navigational device to determine the size of the unemployment gap, one of the two primary goals of its "dual mandate." The results of this paper contain important new information for Fed policymakers, for Fed-watchers, and almost everyone else in the community of policy-makers and practitioners of applied macro. The greatest failure in the history of the PC occurred not within the past five years but rather in the mid-1970s, when the predicted negative relation between inflation and unemployment turned out to be utterly wrong. Instead inflation exhibited a strong positive correlation with unemployment. Failure bred success, as a revolution in thinking rebuilt macroeconomics to be not just about demand, but also about supply. By 1980 diagrams of shifting demand and supply curves had appeared in most macroeconomics textbooks. An econometric model of the inflation rate developed in 1982, soon dubbed the "triangle model", incorporated explicit variables for supply shifts and has successfully tracked inflation behavior since then. The triangle model shows that the puzzle of missing deflation is in fact no puzzle. It can estimate coefficients up to 1996 and then in a 16-year-long dynamic simulation, with no information on the actual values of lagged inflation, predict the 2013:Q1 value of inflation to within 0.50 of a percentage point. The slope of the PC relationship between inflation and unemployment does not decline by half or more, as in the recent literature, but instead is stable. The model's simulation success is furthered here by recognizing the greater impact on inflation of short-run unemployment (spells of 26 weeks or less) than of long-run unemployment. The implied NAIRU for the total unemployment rate has risen since 2007 from 4.8 to 6.5 percent, raising new challenges for the Fed's ability to carry out its dual mandate.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
|Date of creation:||Aug 2013|
|Date of revision:|
|Note:||EFG IFM LS PR|
|Contact details of provider:|| Postal: |
Web page: http://www.nber.org
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Edward P. Lazear & James R. Spletzer, 2012.
"The United States Labor Market: Status Quo or A New Normal?,"
NBER Working Papers
18386, National Bureau of Economic Research, Inc.
- Edward P. Lazear & James R. Spletzer, 2012. "The United States labor market: status quo or a new normal?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 405-451.
- Edward P. Lazear & James R. Spletzer, 2012. "The United States Labor Market: Status Quo or A New Normal?," Working Papers 12-28, Center for Economic Studies, U.S. Census Bureau.
- Jordi Galí & Mark Gertler, 1998.
"Inflation dynamics: A structural econometric analysis,"
Economics Working Papers
341, Department of Economics and Business, Universitat Pompeu Fabra.
- Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
- Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
- Jesse Rothstein, 2012.
"The Labor Market Four Years Into the Crisis: Assessing Structural Explanations,"
NBER Working Papers
17966, National Bureau of Economic Research, Inc.
- Jesse Rothstein, 2012. "The Labor Market Four Years into the Crisis: Assessing Structural Explanations," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 65(3), pages 437-500, July.
- Rothstein, Jesse, 2012. "The Labor Market Four Years Into the Crisis: Assessing Structural Explanations," Institute for Research on Labor and Employment, Working Paper Series qt2x576316, Institute of Industrial Relations, UC Berkeley.
- Sandeep Mazumder & Laurence M. Ball, 2011.
"Inflation Dynamics and the Great Recession,"
IMF Working Papers
11/121, International Monetary Fund.
- Laurence M. Ball & Sandeep Mazumder, 2011. "Inflation Dynamics and the Great Recession," NBER Working Papers 17044, National Bureau of Economic Research, Inc.
- Laurence Ball & Sandeep Mazumder, 2011. "Inflation Dynamics and the Great Recession," Economics Working Paper Archive 580, The Johns Hopkins University,Department of Economics.
- Bårdsen, Gunnar & Jansen, Eilev S. & Nymoen, Ragnar, 2003. "Testing the New Keynesian Phillips curve," Memorandum 18/2002, Oslo University, Department of Economics.
- Romer, Christina D., 1999. "Why Did Prices Rise in the 1930s?," The Journal of Economic History, Cambridge University Press, vol. 59(01), pages 167-199, March.
- John M. Roberts, 2006.
"Monetary Policy and Inflation Dynamics,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 2(3), September.
- Marcello M. EstevÃ£o & Evridiki Tsounta, 2011. "Has the Great Recession Raised U.S. Structural Unemployment?," IMF Working Papers 11/105, International Monetary Fund.
- Robert J. Gordon, 1975. "Alternative Responses of Policy to External Supply Shocks," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(1), pages 183-206.
- Olivier J. Blanchard & Marianna Riggi, 2009.
"Why are the 2000s so different from the 1970s? A structural interpretation of changes in the macroeconomic effects of oil prices,"
NBER Working Papers
15467, National Bureau of Economic Research, Inc.
- Olivier J. Blanchard & Marianna Riggi, 2013. "WHY ARE THE 2000s SO DIFFERENT FROM THE 1970s? A STRUCTURAL INTERPRETATION OF CHANGES IN THE MACROECONOMIC EFFECTS OF OIL PRICES," Journal of the European Economic Association, European Economic Association, vol. 11(5), pages 1032-1052, October.
- Jeffrey C. Fuhrer, 1995.
"The [un]importance of forward-looking behavior in price specifications,"
95-6, Federal Reserve Bank of Boston.
- Fuhrer, Jeffrey C, 1997. "The (Un)Importance of Forward-Looking Behavior in Price Specifications," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 338-50, August.
- Mankiw, N Gregory, 2001.
"The Inexorable and Mysterious Tradeoff between Inflation and Unemployment,"
Royal Economic Society, vol. 111(471), pages C45-61, May.
- 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.
- N. Gregory Mankiw, 2000. "The Inexorable and Mysterious Tradeoff Between Inflation and Unemployment," NBER Working Papers 7884, National Bureau of Economic Research, Inc.
- Robert J. Gordon, 1977. "Can the Inflation of the 1970s be Explained?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(1), pages 253-279.
- Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
- Ian Dew-Becker & Robert J. Gordon, 2005.
"Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income,"
NBER Working Papers
11842, National Bureau of Economic Research, Inc.
- Dew-Becker, Ian & Gordon, Robert J, 2005. "Where did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income," CEPR Discussion Papers 5419, C.E.P.R. Discussion Papers.
- Robert J. Gordon, 1981.
"Price Inertia and Policy Ineffectiveness in the United States, 1890-1980,"
NBER Working Papers
0744, National Bureau of Economic Research, Inc.
- Gordon, Robert J, 1982. "Price Inertia and Policy Ineffectiveness in the United States, 1890-1980," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1087-1117, December.
- Phelps, Edmund S, 1978. "Commodity-Supply Shock and Full-Employment Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(2), pages 206-21, May.
- Alan S. Blinder, 1982. "The Anatomy of Double-Digit Inflation in the 1970s," NBER Chapters, in: Inflation: Causes and Effects, pages 261-282 National Bureau of Economic Research, Inc.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:19390. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.