Phillips Curve Research Articles

A Comparative Analysis of the Effects of Price Instability and Output Volatility on Economic Growth

Historical data indicate that the relationship between inflation and output does not align closely with the Philips curve's implications. Since the late 1980s, monetary policy has prioritized price stability as a key component of sustainable long-term economic growth. This emphasis reflects policymakers' assumption that output volatility poses less risk to long-term growth than inflation volatility, though this assumption lacks empirical support in the literature. To address this gap, this study investigates the impact of inflation and output volatility on economic growth by analyzing panel data from 1990 to 2020 across 68 countries. Fixed Effect Models are employed to account for country-specific, time-invariant factors that may influence the relationship between volatilities and growth. The findings reveal a significant negative impact of output volatility on economic growth, even when inflation volatility is accounted for, suggesting that policymakers should consider output volatility alongside price stability to support sustained economic growth.

A Neural Phillips Curve and a Deep Output Gap

Many problems plague empirical Phillips curves (PCs). Among them is the hurdle that the two key components, inflation expectations and the output gap, are both unobserved. Traditional remedies include proxying for the absentees or extracting them via assumptions-heavy filtering procedures. I propose an alternative route: a Hemisphere Neural Network (HNN) whose architecture yields a final layer where components can be interpreted as latent states within a Neural PC. First, HNN conducts the supervised estimation of nonlinearities that arise when translating a high-dimensional set of observed regressors into latent states. Second, forecasts are economically interpretable. Among other findings, the contribution of real activity to inflation appears understated in traditional PCs. In contrast, HNN captures the 2021 upswing in inflation and attributes it to a large positive output gap starting from late 2020. The unique path of HNN’s gap comes from dispensing with unemployment and GDP in favor of an amalgam of nonlinearly processed alternative tightness indicators.

AN EMPIRICAL EXAMINATION OF THE VALIDITY OF GENDER-INDEXED PHILLIPS CURVE IN TURKIYE

The potential existence and structure of the relationship between inflation and unemployment is a frequently examined topic in the literature. A.W.H. Phillips (1958) explored the correlation between these two significant economic variables in the context of the United Kingdom, highlighting the trade-off relationship between them. This seminal work has led various economists to rigorously investigate the same phenomenon across different countries and country groups. The primary reason for this intense scrutiny is the assertion that monetary policies implemented in response to economic shocks may push these two variables in opposite directions. In this regard, the significant shocks experienced in Turkey in recent years concerning inflation and unemployment have made it particularly intriguing to test the validity of the Phillips Curve for Turkey. The aim is to provide economic decision-makers with findings that can guide them in formulating more realistic, original, and valid policy decisions. This study tests the validity of the Phillips Curve relationship for Turkey. Utilizing monthly data from 2005 to 2023, the unemployment rates are modeled separately for male and female unemployment rates, distinguishing this study from others. The analysis employs the Johansen Cointegration Test and concludes that the Phillips Curve theory holds true for Turkey.

Did Monetary Policy Kill the Phillips Curve? Some Simple Arithmetics

Abstract An apparent disconnect has taken place between inflation and economic activity in the pre-COVID US economy, causing some to believe that the Phillips curve has flattened. We argue that this view may be premature. Using New Keynesian theory and estimated SVAR models, we decompose fluctuations in US macro data into the components driven by demand and supply disturbances, and confront the inflation disconnect with some simple arithmetics. This exercise confirms a relatively stable Phillips curve slope while the demand curve has flattened substantially. Our results are consistent with a shift towards firmer monetary policy commitment to inflation stability.

A dynamically consistent discretization method for the Goodwin model with nonlinear Phillips curve. Comparing qualitative and quantitative dynamics

AbstractThe Goodwin model is a widely used economic growth model able to explain endogenous fluctuations in employment rate and wage share; in its initial version, the standard Phillips curve is used. In the present work, we suggest a revised Phillips curve that takes into account how the wage share influences the rate of changes of the wage itself thus obtaining a continuous-time modified Goodwin model. Since applying models to real data often requires working in a discrete-time setup, we then move from the continuous-time to the discrete-time version of the proposed model, by using a general polynomial discretization method in backward and forward-looking (hybrid discretization). By comparing the continuous-time system to its discrete-time counterpart we prove that fixed points and local dynamics do not change, as long as the time step is not too high. Moreover, numerical simulations employing Dynamic Time Warping, cross-correlation, and semblance analysis consistently affirm that enhancing the similarity of quantitative dynamics is achieved by reducing the time step.

Labour market skills, endogenous productivity and business cycles

This paper analyses how labour market heterogeneity affects unemployment, productivity and business cycle dynamics. To this aim, we set up a model with asymmetric search and matching frictions across skilled and unskilled workers, and endogenous productivity through R&D investment and intangible capital accumulation. Skill mismatch and skill-specific labour market institutions have three main effects on business cycles and growth dynamics. First, the relative scarcity of skilled workers increases the natural rate of unemployment and reduces total factor productivity with long-run effects on the growth rate of output. Second, skill heterogeneity in the labour market generates asymmetric outcomes and amplifies measures of employment, wages and consumption inequality. Finally, the model provides important insights for the Phillips and Beveridge curves. Incorporating skill heterogeneity leads to a flattening of the Phillips curve as wages and unemployment respond unevenly across skill types. Also, the model generates sideward shifts of the Beveridge curve following business cycle shocks, with the extent of these shifts depending on the degree of skill heterogeneity.

Money/Asset Ratio as a Predictor of Inflation

This paper modifies the quantity theory of money to forecast inflation, relating the latter to scale variables such as monetary aggregate M2 and government bonds that measure the money demand for asset transactions. The out-of-sample forecast results show that at least since the early 1990s, the money/asset model that uses the money supply/government debt ratio as a predictor has been significantly improved upon univariate and multivariate models, such as Phillips curve and term spread models, for forecasting U.S. inflation over one- to three-year horizons. In using real-time vintage data, I find that, since 2000Q1, the forecasts derived from the money/asset model have slightly improved upon those from the Greenbook in forecasting quarter-over-quarter CPI inflation at short horizons, from two- to four-quarter. These results imply that the Federal Reserve can use the money supply/government debt ratio to forecast and control the inflation rates, coordinating monetary policy with fiscal policy. Moreover, the money supply/government debt ratio can partly explain the U.S. inflation dynamics from the early 1960s until COVID-19.

Is There a Stable Relationship between Unemployment and Future Inflation?

Evaluating the stability of the Phillips curve using aggregate data is challenging due to the bias that endogenous monetary policy imparts on estimated Phillips curve coefficients. We argue that regional data can be used to identify the structural relationship between unemployment and inflation. Our analysis, using city- and state-level data from 1977 to 2017, is consistent with the notion that both the reduced-form and the structural parameters of the Phillips curve are, to a substantial degree, quite stable. (JEL E12, E24, E31, E52, E58)

Inflationary dynamics of labour market activity: Evidence from the Czech Republic

This paper provides an in-depth investigation into the intricacy of inflation dynamics in the Czech Republic, with particular emphasis on the influence exerted by labor market activity. The research employed principal component analysis and the local projections methodology proposed by Jorda (2005) in the context of the Phillips curve framework, followed by the extension of the analysis via the introduction of a nuanced state dependence dimension that recognizes that the impact of labor market activity on inflation may be contingent upon the broader economic situation. Our findings revealed the statistically significant impact of labor market activity on inflation. Specifically, a one standard deviation increase in the labor market activity component leads to an accumulated increase in inflation of approximately 3 percentage points over a three-year horizon. Our non-linear model uncovered the pivotal interaction between state dependence and the impact on inflation. The findings revealed that during expansionary periods, labor market pressures can be effectively managed for a limited period, albeit with a slight escalation in prices. However, over an extended period, the labor market is susceptible to encountering constraints that lead to markedly higher inflation rates - almost twice as high as those observed during recessionary periods. We subjected our benchmark results to extensive robustness verification.

Cash transfers and the Phillips curve: The case of Brazil during the pandemic

This paper investigates the linear and nonlinear effects of the pandemic period on the dynamics of the Brazilian inflation through the estimation of a hybrid Phillips curve. Despite the undisputed socio-economic benefits, cash transfers paid by the government to low-income families increased inflation, with an estimated coefficient similar in magnitude to the output gap. The backward-looking component decreased while the forward-looking component increased sharply, suggesting a shift in the price-setting behavior toward anticipating fluctuations in the business cycle. There was also a significant reduction in the flatness of the Phillips curve, as the output gap coefficient more than doubled during this period. These findings might be explained by the unprecedented combination of sectorial increases in demand, a decrease in aggregate supply, anticipated money supply growth, and loose monetary policy. They unveil an undesired side effect of cash transfers on inflation that adversely affected the purchase power of the program beneficiaries.

Greenflation, a myth or fact? Empirical evidence from 26 OECD countries

Among the various effects of the green transition on the macroeconomy, we examined the unintended effects of the green transition on inflation, the so-called “greenflation”. We analyzed panel data from 26 OECD countries covering the period from 2005 to 2019 using four models based on the New Keynesian Phillips curve model. To date, only a few studies have examined greenflation, particularly in terms of empirical investigation. The main contribution of this study to the literature is to provide empirical evidence of greenflation. We also provide empirical evidence on the issues in the NKPC literature that the output gap better explains inflation dynamics than unit labor costs and confirm the demise of the Phillips curve. Estimates from the Common Correlated Effect Mean Group (CCEMG), Augmented Mean Group (AMG), and Panel Corrected Standard Error (PCSE) models indicate that the green transition has an upward inflationary impact on headline inflation, but no significant impact on core inflation. In addition, we have examined four circumstances under which the green transition may affect inflation that have not been sufficiently discussed in the literature: increased green transition spending, carbon pricing, increased demand for critical minerals, and the low energy density of renewable energy. Each of these circumstances has the potential to exert both upward and downward pressures simultaneously. Our suggestion to policymakers is that they do not yet need to change their current view of monetary policy with respect to greenflation, but they should carefully consider policy designs that take into account the unintended effects of the energy transition.

The art of paradigm maintenance: how the New Keynesian ‘Science of Monetary Policy’ tries to deal with the inflation of 2021–2023

The macroeconomic models used by major institutions including the Federal Reserve and the International Monetary Fund (IMF) failed to predict the inflation surge during 2021–2023. The output gap, the unemployment gap, the New Keynesian Phillips curve and inflation expectations did not give timely and relevant signals. The re-emergence of inflation thus threw the ‘science of monetary policy’ off the rails. Faced with the choice between changing their paradigm and proving that there is no need to do so, the ‘scientists of monetary policy’ got busy on the proof. As a result, a number of ad hoc epicycles have been added to the New Keynesian analytical core – with the help of which one can claim to be able to explain the sudden acceleration of inflation post factum. This paper critically reviews the theoretical and empirical merits of three recent tweaks to the New Keynesian core: using the vacancy ratio as the appropriate measure of real economic activity; hammering on the considerable risk of an imminent wage–price spiral; and the resurrection of the non-linear Phillips curve. The paper concludes by drawing out sobering lessons concerning the art of paradigm maintenance as practiced by the ‘scientists of monetary policy’.

The New Keynesian Phillips Curve and r* ${r}^{* }$

AbstractIn this article, I argue that shifts in the natural rate of interest provide important insights for the New Keynesian Phillips Curve (NKPC). The deviation of the real interest rate from the natural interest rate (interest rate gap) captures the monetary policy stance, which is important for the dynamics of inflation and the output gap in the wake of persistent and permanent variation in the natural rate of interest. I present the evolution of the estimates of the Taylor‐rule consistent‐ natural interest rate, and thus the associated path of the expectations of future inflation via the Fisherian relationship. The path of these two variables has implications for estimation of the NKPC.

The Phillips Curve in Australia in the Era of Inflation Targeting

AbstractAustralia, like many other countries, experienced an unexpected surge in inflation following the COVID‐19 pandemic. This has renewed interest in the Phillips curve because of its important implications for monetary policy. We estimate the price Phillips curve in the post‐inflation targeting period using the most recent state‐level data. Identification relies on variation in regional demand that policymakers do not aim to stabilize. After controlling for cost‐push shocks and equilibrium unemployment, we obtain a modest slope of the Phillips curve and, more importantly, we do not find any steepening of the Phillips curve in the post‐COVID period. Without correct identification, the post‐COVID Phillips curve would be steeper as documented for other countries including the United States. We also find that the slope gradually decreases with the level of unemployment.

Does the environmental Phillips curve hypothesis hold within the Ghanaian context?

This study examines the relationship between environmental quality and unemployment in Ghana using annual data spanning the period from 1990 to 2019. It also assesses the impact of gender-segregated unemployment rate on environmental quality. The study employed the Autoregressive Distributive Lag (ARDL) error correction model to estimate the relationship among the variables. In addition, the Fully Modified Ordinary Least Squares (FMOLS) and the Dynamic Ordinary Least Squares (DOLS) estimation procedures were employed to check for robustness of the ARDL results. Findings indicate a positive effect of total unemployment rate on environmental quality in Ghana in the long-run and also in the short-run. In the case of the gender-segregated unemployment, the findings reveal that in both short-run and long-run, a rise in female unemployment causes a deterioration in environmental quality in Ghana. The results also validated the Environmental Phillips Curve (EPC) hypothesis in the case of male unemployment. Thus, given that there is no general pattern in the findings, the study concludes that the Environmental Phillips Curve (EPC) hypothesis does not hold within the Ghanaian context.

The Slope of the Phillips Curve and the Optimal Average Inflation Targeting Window

AbstractThe slope of the Phillips curve has been shown to be flatter in recent years, including in Australia. How does this impact the optimal targeting window for a central bank conducting an average inflation targeting policy? This article shows that, in the face of the flattening of the Phillips curve, it is desirable to increase the targeting window. Doing so would lead to lower inflation fluctuations and to a non‐trivial welfare gain. In a persistently higher‐than‐target inflation, high‐interest‐rate environment, this implies that the central bank should keep the nominal interest rate higher for longer.

Oil jump tail risk as a driver of inflation dynamics

In this paper, we look at the role of various oil jump tail risk measures as drivers of both U.S. headline and core inflation. Those measures are first computed from high-frequency oil future prices and are then introduced into standard regression models in order to (i) assess in-sample determinants of inflation, (ii) assess overtime the evolution of inflation drivers, (iii) estimate impulse response functions and (iv) forecast inflation out-of-sample for various horizons. Empirical results suggest that oil jump tail risk measures contain useful information to describe inflation dynamics, generally leading to upward inflationary pressures. Even after controlling from standard variables involved in a Phillips curve, goodness-of-fit measures show evidence of a gain, in particular for headline inflation. Overall, we observe that oil jump tail risk measures are contributing more to inflation dynamics since the Covid-19 crisis.

Is the slope of the euro area Phillips curve steeper than it seems? Heterogeneity and identification

Heterogeneity in Phillips Curve slopes among members of a monetary union can lead to biased to estimates of the union-wide ‘average’ slope in reduced form regressions. The intuition is that in a monetary union with heterogeneous regional Phillips curve slopes, the central bank, aiming at stabilizing demand shocks, will react stronger to shocks in regions with steep slopes compared to shocks in regions with flat slopes. Using a simple New-Keynesian model of a monetary union we show that when failing to account for this heterogeneity in the estimation, reduced form estimates of the union-wide ‘average’ slope suffer from a sizable bias. Empirically, we show that a similar bias exists in EMU data and slope estimates that adequately control for slope heterogeneity are steeper than those from reduced form OLS regressions.

Examining the New Keynesian Phillips Curve in the U.S.: Why has the relationship between inflation and unemployment weakened?

This paper conducts a comprehensive review of the relationship between inflation and unemployment in the U.S. as described by the Phillips curve in a New Keynesian framework and investigates whether this relationship has changed systematically over time. We also aim to identify possible explanations for these changes. Three different hypotheses are discussed to assess whether they are consistent with more recent developments, such as the evolution of inflation expectations, the impact of globalization, and possible nonlinearities in the functional shape of the Phillips curve. We find that the relationship between inflation and unemployment has weakened since the 1980s and especially during the Covid-19 pandemic due to forces of globalization and better anchored inflation expectations resulting from more credible monetary policy. This has led to question of whether the Phillips curve is outdated. We conclude with the implications of these findings for the conduct of monetary policy.

Phillips meets Beveridge

The Phillips curve plays a central role in the macroeconomics literature. However, there is little consensus on the forcing variable that drives inflation in the model, i.e., on the appropriate measure of “slack” in the economy. In this work, we systematically assess the ability of variables commonly used in the literature to (i) predict and (ii) explain inflation fluctuations over time and across U.S. metropolitan areas. In particular, we exploit a newly constructed panel dataset with job openings and vacancy filling cost proxies covering 1982–2022. We find that the vacancy-unemployment (V/U) ratio and vacancy filling cost proxies outperform other slack measures, in particular the unemployment rate. Beveridge curve shifts—notably, movements in matching efficiency—are responsible for the superior performance of the V/U ratio over unemployment.