IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/19390.html
   My bibliography  Save this paper

The Phillips Curve is Alive and Well: Inflation and the NAIRU During the Slow Recovery

Author

Listed:
  • Robert J. Gordon

Abstract

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.

Suggested Citation

  • Robert J. Gordon, 2013. "The Phillips Curve is Alive and Well: Inflation and the NAIRU During the Slow Recovery," NBER Working Papers 19390, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19390
    Note: EFG IFM LS PR
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w19390.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. John M. Roberts, 2006. "Monetary Policy and Inflation Dynamics," International Journal of Central Banking, International Journal of Central Banking, vol. 2(3), September.
    2. 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.
    3. 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 338-350, August.
    4. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages 45-61, May.
    5. 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.
    6. 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.
    7. 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.
    8. Jesse Rothstein, 2012. "The Labor Market Four Years into the Crisis: Assessing Structural Explanations," ILR Review, Cornell University, ILR School, vol. 65(3), pages 467-500, July.
    9. 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.
    10. Marcello M. Estevão & Evridiki Tsounta, 2011. "Has the Great Recession Raised U.S. Structural Unemployment?," IMF Working Papers 11/105, International Monetary Fund.
    11. 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.
    12. Bårdsen, Gunnar & Jansen, Eilev S. & Nymoen, Ragnar, 2003. "Testing the New Keynesian Phillips curve," Memorandum 18/2002, Oslo University, Department of Economics.
    13. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
    14. 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.
    15. 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.
    16. 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.
    17. Phelps, Edmund S, 1978. "Commodity-Supply Shock and Full-Employment Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(2), pages 206-221, May.
    18. 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.
    Full references (including those not matched with items on IDEAS)

    More about this item

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • J60 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - General
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. 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: (). General contact details of provider: http://edirc.repec.org/data/nberrus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.