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The L-Shaped Phillips Curve: Theoretical Justification and Empirical Implications

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  • Narayana R. Kocherlakota

Abstract

This paper has two parts. In the first part, I demonstrate that, in the absence of price and wage bounds, monetary models do not have current equilibria - and so lack predictive content - for a wide range of possible policy rules and/or beliefs about future equilibrium outcomes. This non-existence problem disappears in models in which firms face (arbitrarily loose) finite upper bounds on prices or positive lower bonds on nominal wages. In the second part, I study the properties of a class of dynamic monetary models with these kinds of bounds on prices/wages. Among other results, I show that these models imply that the Phillips curve is L-shaped, are consistent with the existence of permanently inefficiently low output (secular stagnation), and do not imply that forward guidance is surprisingly effective. I show too that economies with lower nominal wage floors have even worse equilibrium outcomes in welfare terms. It follows that models with arbitrarily low but positive nominal wage floors are not well approximated by models without wage floors.

Suggested Citation

  • Narayana R. Kocherlakota, 2017. "The L-Shaped Phillips Curve: Theoretical Justification and Empirical Implications," NBER Working Papers 24086, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24086
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    References listed on IDEAS

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    2. Olivier Blanchard & Jordi Galí, 2007. "Real Wage Rigidities and the New Keynesian Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 35-65, February.
    3. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
    4. Marco Del Negro & Marc P. Giannoni & Christina Patterson, 2023. "The Forward Guidance Puzzle," Journal of Political Economy Macroeconomics, University of Chicago Press, vol. 1(1), pages 43-79.
    5. Emi Nakamura & Jón Steinsson, 2013. "Price Rigidity: Microeconomic Evidence and Macroeconomic Implications," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 133-163, May.
    6. Matthew O. Jackson, 1992. "Implementation in Undominated Strategies: A Look at Bounded Mechanisms," Review of Economic Studies, Oxford University Press, vol. 59(4), pages 757-775.
    7. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
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    Cited by:

    1. Harding, Martín & Lindé, Jesper & Trabandt, Mathias, 2022. "Resolving the missing deflation puzzle," Journal of Monetary Economics, Elsevier, vol. 126(C), pages 15-34.

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    More about this item

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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