Expectations-augmented Phillips Curve Research Articles

Do professional forecasters believe in the Phillips curve?

The expectations-augmented Phillips curve (PC) is a cornerstone of many macroeconomic models. We consider the extent to which professional forecasters’ inflation and unemployment rate forecasts are ‘theory consistent’, and find much heterogeneity. Perceptions about the responsiveness of inflation to the unemployment rate are shown to depend on whether the respondent was active earlier or later during the period 1981–2019, and on whether the respondent happened to forecast at times of tight labour markets.Theory consistency is related to more accurate forecasts at the shortest horizon but not significantly so at longer horizons. At longer horizons PC-model heterogeneity accounts for the lion’s share of the observed disagreement in reported inflation forecasts.

An Empirical Test for Natural Rate of Unemployment and Expectations Augmented Phillips Curve Hypothesis in Perspective of Chinese Economy

This research study investigates the natural rate of unemployment and the Expectations Augmented Phillips Curve for Chinese economy by analyzing the data ranging from 1980 to 2020. The empirical methodology of this study test the relationship between inflation rate and rate of unemployment which proved to be negatively significant (it proves the existence of classical Phillips Curve around 1960) in China. The study also analyzed the Expectations Augmented Phillips Curve allowing the effects of price expectations on money wages increases. Finally, the study also analyzed the natural rate of unemployment for China that was around 4.86 per cent that can be compared with the natural rate of unemployment (as prescribed by economists 4 to 5 per cent). The study suggests certain tools that will be helpful for policymakers in maintaining the conditions of stable inflation in China.

Central banks and inflation: where do we stand and how did we get here?

The inability of central banks to attain their target inflation rates in recent years has raised questions about the extent to which central banks can control the inflation process. This paper discusses the evolution of thought and evidence since the 1960s on the determinants of inflation and the role that should be played by central banks. The paper highlights the roles played by two streams of thought associated with Milton Friedman: monetarist theories predicting a key role for monetary aggregates in determining inflation and the rise in popularity of the expectations-augmented Phillips curve. The author discusses the influence of the latter in determining the modern consensus on central-bank institutions and the relative roles for fiscal and monetary policies. The paper concludes with a discussion of macroeconomic developments since 2010 and current policy options to stimulate the economy and restore inflation to its target levels, including the merits of ‘helicopter money’.

Prospects for inflation in a high pressure economy: Is the Phillips curve dead or is it just hibernating?

As the US labor market has tightened beyond full employment with relatively little evidence of inflation pressure, observers are increasingly inclined to declare the demise of the Phillips curve, that is, the flattening of its slope to zero. This paper reviews a substantial range of empirical evidence on this point, by assessing the performance of the conventional expectations-augmented Phillips curve for both prices and wages, based on both historical macro or national level data and panel data for states and MSAs (cities). National data going back to the 1950s and 60s yield strong evidence of negative slopes and significant nonlinearity in those slopes, with slopes much steeper in tight labor markets than in easy labor markets. This evidence of both slope and nonlinearity weakens dramatically based on macro data since the 1980s for the price Phillips curve, but not the wage Phillips curve. However, the endogeneity of monetary policy and the lack of variation of the unemployment gap, which has few episodes of being substantially below zero in this sample period, makes the price Phillips curve estimates from this period less reliable. At the same time, state level and MSA level data since the 1980s yield significant evidence of both negative slope and nonlinearity in the Phillips curve. The difference between national and city/state results in recent decades can be explained by the success that monetary policy has had in quelling inflation and anchoring inflation expectations since the 1980s. We also review the experience of the 1960s, the last time inflation expectations became unanchored, and observe both parallels and differences with today. Our analysis suggests that reports of the death of the Phillips curve may be greatly exaggerated.

Is Inflation Just Around the Corner? The Phillips Curve and Global Inflationary Pressures

Tightening labor markets in the United States and other advanced economies suggest inflation should be on the rise, yet it remains subdued. Is the Phillips curve broken? We bring together surveys of household or firm expectations for 18 countries to estimate an expectations-augmented Phillips curve. We find strong evidence of a Phillips curve relationship: the Phillips curve is alive and well. The fact that inflation remains well below inflation expectations, both in the United States and abroad, suggests that there remains significant slack in labor markets.

DID IRVING FISHER REALLY DISCOVER THE PHILLIPS CURVE?

Economic lore has it that, with his 1926 article, “A Statistical Relation between Unemployment and Price Changes,” Irving Fisher “discovered the Phillips curve.” Did he? This paper argues he did not, for two reasons. One: the statistical relationship between inflation and unemployment that Fisher described in his 1926 article was contemporaneously described by Alvin Hansen, Henri Fuss, John Rotherford Bellerby, and Arthur Pigou in their own studies. Two: the statistical relationship that Fisher, Hansen, Fuss, Bellerby, and Pigou described is substantially different from the statistical relationship that Alban William Phillips described in his famous 1958 paper, as well as the many variations of the Phillips curve in the literature, including today’s conventional expectations-augmented Phillips curve. To correct the economic lore, the work of Fisher, Hansen, Fuss, Bellerby, and Pigou on the statistical relationship between inflation and unemployment and Phillips’s 1958 paper should be viewed as separate contributions.

THE PHILLIPS CURVE AND AN ASSUMED UNIQUE MACROECONOMIC EQUILIBRIUM IN HISTORICAL CONTEXT

An early post-WWII debate concerned the most desirable demand and inflationary pressures at which to run the economy. Context was provided by Keynesian theory devoid of a full employment equilibrium and containing its mainly forgotten, but still relevant, microeconomic underpinnings. A major input came with the estimates provided by the original Phillips curve. The debate seemed to be rendered obsolete by the curve’s expectations-augmented version with its natural rate of unemployment, and associated unique equilibrium GDP, as the only values consistent with stable inflation. The current behavior of economies with the successful inflation targeting is inconsistent with this natural-rate view, but is consistent with evolutionary theory in which economies have a wide range of GDP-compatible stable inflation. Now the early post-WWII debates are seen not to be as misguided as they appeared to be when economists came to accept the assumptions implicit in the expectations-augmented Phillips curve.

La tasa natural de desempleo en Colombia 2003 – 2010

The main goal of this paper is to calculate the Natural Rate of Unemployment (NRU) for Colombia for the years 2003 to 2010. It is done through the econometric estimation of an Expectations-augmented Phillips curve. The found NRU is 8.7%. This is the lowest level that can be unemployment through economic policies in the short term without generating inflationary pressures. Levels below this percentage only are possible with the implementation of structural economic policies such as training of the workforce and improving information systems in the labor market.

Decomposing the misery index: A dynamic approach

AbstractThe misery index (the unweighted sum of unemployment and inflation rates) was probably the first attempt to develop a single statistic to measure the level of a population’s economic malaise. In this letter, we develop a dynamic approach to decompose the misery index using two basic relations of modern macroeconomics: the expectations-augmented Phillips curve and Okun’s law. Our reformulation of the misery index is closer in spirit to Okun’s idea. However, we are able to offer an improved version of the index, mainly based on output and unemployment. Specifically, this new Okun’s index measures the level of economic discomfort as a function of three key factors: (1) the misery index in the previous period; (2) the output gap in growth rate terms; and (3) cyclical unemployment. This dynamic approach differs substantially from the standard one utilised to develop the misery index, and allow us to obtain an index with five main interesting features: (1) it focuses on output, unemployment and inflatio...

The Global Financial Crisis and Undergraduate Macroeconomics

The Global Financial Crisis (GFC) of 2008 and 2009 was the deepest global cyclical downturn since the Great Depression of 1929-1933. Historically, major worldwide economic events have influenced economic thought and this has been reflected in the economics curriculum. For example, the Great Depression ushered in Keynesian economics; and the oil price shocks of the 1970s contributed to stagflation,1 which led to recognition of the role of aggregate supply and expectations through the expectations-augmented Phillips curve. The GFC and its aftermath have already challenged established thought in some areas of macroeconomics, which has implications for undergraduate macroeconomics. A proper understanding of the causes and effects of the GFC must draw on some ideas that do not normally feature in undergraduate macroeconomics subjects and must pull together strands from other economics subjects as well as subjects from the disciplines of accounting and finance. This article first explains that debt and asset prices can be integrated into the standard aggregate demand (AD)-aggregate supply (AS) model and discusses the importance of understanding the relationship between equity, assets and liabilities. This is followed by a brief discussion of the implications of the GFC for monetary and fiscal policy.

US Growth And Inflation

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">This paper tests the relation between inflation and growth in the US. This relation is negative and statistically significant even with a monthly frequency. Moreover, the impact is higher with quarterly data, relative to annual data, and higher with monthly data relative to quarterly data. The relation remains robust (1) with IV (2SLS) estimation, (2) when inflation is divided into positive and negative components, (3) when it is divided into expected and unexpected components, and (4) when the applied model is an expectations-augmented Phillips curve. Although the paper argues that the theory that should explain this negative relation is the demand for real balances, the evidence is also consistent with a simple bivariate association. </span></span></p>

Verðbólguspár og verðbólgumarkmið Seðlabanka Íslands

Samkvæmt lögum um Seðlabanka Íslands frá 2001 er meginmarkmið hans að stuðla að stöðugu verðlagi. Hagfræðisvið Seðlabankans býr til ársfjórðungslíkan af íslenska hagkerfinu og birtir lýsingu á því. Þar er verðbólgu lýst með Phillips-ferli að viðbættum væntingum. Stýrivextir eru helsta stjórntæki bankans. Þeir fylgja Taylorreglu í líkaninu og hefur hún löngum verið í góðu samræmi við raunverulegar vaxtaákvarðanir. Þá tók bankinn upp þá stefnu að birta spár um verðbólgu með stýrivaxtaferil þar sem verðbólgumarkmiðið næðist innan þriggja ára. Áhrif stýrivaxta á umframeftirspurn og gengi dugðu ekki til þess. Það hafðist þó með því að reikna með að verðbólguvæntingar löguðu sig hratt að markmiðinu þó að engin merki væru um slíka hegðun í gögnum um vaxtamuninn. Í ársfjórðungslíkaninu 2009 er vaxtamuninum sleppt, en verðbólguvæntingar metnar með fyrra gildi verðbólgu, reiknaðri spá um verðbólgu eftir tvö ár og beinni tengingu við markmiðið. Þetta líkan spáir einnig hraðri leitni að markmiðinu, en uppfyllir ekki lágmarkskröfur um samræmi við fyrirliggjandi verðmælingar.

Central bank transparency and shocks

According to the literature, in an expectations-augmented Phillips curve model, opacity is always preferred to transparency on central bank forecasts. By modelling the private sector's behavior explicitly, we show that transparency reduces the shocks. Consequently, transparency can be preferred.

Inflation expectations and macroeconomic dynamics: The case of rational versus extrapolative expectations

The motivation of this paper is to understand the effects of coupling a macroeconomic model of inflation rate dynamics, relying on an aggregate expectation, to a heterogeneous expectations framework. A standard model composed of Okun's law, an expectations-augmented Phillips curve and an aggregate demand relation is extended to allow agents to select between trend-following and rational expectations to predict the future inflation rate. Using a mixture of analytical and numerical tools we investigate the model's dynamics and discuss the conditions under which the extended model leads to endogenous fluctuations in macroeconomic variables. Some preliminary results are offered for the case in which a Taylor-like monetary policy rule is included in the model.

Edmund Phelps and Modern Macroeconomics

Edmund Phelps, winner of the 2006 Nobel Prize in Economics, has been a central figure in the development of macroeconomics since his 1961 article ‘The Golden Rule of Accumulation’ on optimal economic growth. His 1967–68 critique of the stability of the Phillips curve trade-off, together with Friedman (1968), led to the expectations-augmented Phillips curve and the natural rate hypothesis. His work on the choice-theoretic microeconomic foundations of wage, price, and employment dynamics under imperfect information, changed how economists do macroeconomics. Phelps subsequently developed natural rate models in a non-monetary, structuralist direction distinct from Friedman's monetarism and from New Classical economics, analyzing the natural rate of unemployment as a function of the real structure of the economy: real sectoral demands, factor supplies, technology, taxes, subsidies, tariffs, and real interest and exchange rates.

The New Keynesian Phillips Curve: Empirical Results for Luxembourg

The New Keynesian Phillips curve (NPC) differs from the conventional expectations-augmented Phillips curve in that it is forward-looking and links inflation to a measure of marginal cost instead of unemployment or the output gap. More fundamentally, the NPC is derived from New Keynesian models that combine nominal rigidities with individual optimising behaviour and model-consistent (rational) expectations. Because the NPC is grounded in micro-theory (unlike the conventional expectations-augmented Phillips curve), it is robust to some forms of the Lucas critique and may serve to analyse the impact structural changes such as increased price flexibility may have on inflation. New Keynesian Phillips curve estimates for Luxembourg using the Gali and Gertler (1999) hybrid form suggest that firms change prices often but tend to use backward-looking rules-of-thumb instead of resetting prices optimally using forward-looking expectations. In terms of policy implications, although the results suggest prices in Luxembourg are relatively flexible, the prevalence of backward-looking price setting implies greater inflation persistence and a higher sacrifice ratio attached to disinflationary monetary policy. From the perspective of individual firms, backward-looking price setting may be a rational response in a very small open economy because of its vulnerability to external shocks. Small size and openness plausibly imply higher costs of collecting information and lower benefits from optimal price setting.

MODELLING INFLATION IN SOUTH AFRICA: A MULTIVARIATE COINTEGRATION ANALYSIS

We employ an expectations augmented Phillips curve framework to investigate the link between inflation, unit labour costs, the output gap, the real exchange rate and inflation expectations. Using multivariate cointegration techniques, we find evidence consistent with mark-up behaviour of output prices over unit labour costs. Most importantly, we find that the mark-up in the South African economy is much higher than in the U.S. For South Africa we find a markup of about 30 per cent: three times as high as the 10 per cent markup found for the U.S.

Structural Changes And Models Of Inflation In South Africa

In the past three decades South Africa has undergone a number of structural changes in the economy, which may have contributed to parameter instability in inflation equations. In this study the out-of-sample forecasting performance of three single equation models for inflation in South Africa is examined without imposing the restriction that coefficients are fixed over time. A time-varying parameter regression (VPR) technique based on the recursive application of the Kalman filter is used to evaluate the stability of the models using South African quarterly data from 1971.1 to 1998.3, with 1998.4 to 2001.3 excluded from the estimated sample period in order to do an ex post forecast evaluation. It is found that the parameters of the expectations-augmented Phillips curve and the traditional monetarist models for inflation are fairly stable over the sample period, whereas the money demand model for inflation shows signs of changing parameters over time. This is in accordance with some changes in monetary policy during the 1980s and a degree of financial liberalisation since 1994. It is furthermore shown that, under conditions of structural instability, the VPR money demand model can substantially reduce out-of-sample forecasting errors compared to its fixed-coefficient counterparts.

A model of inflation targeting in an open economy

AbstractThis paper develops a model of inflation targeting in a small open economy under floating exchange rates. The central bank follows a simple Taylor rule to achieve a target inflation rate, and the inflation process itself is determined by an expectations augmented Phillips curve mechanism. The behaviour of the exchange rate is governed by uncovered interest parity as a benchmark case, and both exchange rate expectations and inflationary expectations are assumed to be held with perfect foresight. Finally, the level of output in the economy varies gradually in response to excess demand in the goods sector. The paper analyses the effects of two shocks, a reduction in the central bank's target inflation rate and a sudden increase in aggregate demand. The effects of these shocks in a large country engaged in inflation targeting on the outside world follow from these results. Copyright © 2004 John Wiley & Sons, Ltd.

The inflation bias revisited: theory and some international evidence

The Kydland–Prescott, Barro–Gordon inflation bias result hinges on policymakers aiming at employment above potential. This has been questioned by academics and policymakers on the ground of realism. We show that even if policymakers target the normal level of employment, a bias arises if they are uncertain about economic conditions and are more sensitive to employment below than above normal. This view implies a positive association between inflation and the variance of output shocks. Cross‐sectional empirical evidence from OECD economies supports this implication. We also discuss the consequences for the transparency of monetary policy and for central bank reform.