Inflation Dynamics and the Great Recession

Abstract

This paper examines inflation dynamics in the Unite States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960-2007 are used to predict inflation over 2008-2010: inflation should have fallen by more than it did. We resolve this puzzle with two modifications of the Phillips curve, both suggested by theories of costly price adjustment: we measure core inflation with the median CPI inflation rate, and we allow the slope of the Phillips curve to change with the level and variance of inflation. We then examine the hypothesis of anchored inflation expectations. We find that expectations have been fully "shock-anchored" since the 1980s, while "level anchoring" has been gradual and partial, but significant. It is not clear whether expectations are sufficiently anchored to prevent deflation over the next few years. Finally, we show that the Great Recession provides fresh evidence against the New Keynesian Phillips curve with rational expectations.

Domestic and global output gaps as inflation drivers: What does the Phillips curve tell?

“…Similarly, Blanchard et al (2015) estimate a Phillips curve relationship over the past 50 years for 20 advanced economies, and find that the effect of unemployment on inflation decreased until the early 1990s, but has remained roughly stable since then. Ball and Mazumder (2011) find that the Phillips curve has flattened since the mid-1980s, and that the backward-looking Phillips curve estimated over 1985-2007 continues to fit after 2007 applied to median CPI inflation. Gordon (2013) reports that a Phillips curve which allows for a time-varying NAIRU can explain the behaviour of both headline and core US inflation (based on the deflator for Personal Consumption Expenditures) over the five decades to 2013.…”

Trade Exposure and the Evolution of Inflation Dynamics

“…12 Compared with the former, this latter indicator of slack increased notably less during the Great Recession and has also returned more quickly to its pre-recession levels, thus providing substantially less deflationary impetus. And although it has proven difficult to identify structural changes in the economy that could account for the diminished sensitivity of inflation to the level of unemployment, a number of economists have singled out the apparent flattening of the Phillips curve as an important reason for the fact that the U.S. economy did not experience a Fisherian debt-deflation spiral during the 2008-2009 global financial crisis (see Ball and Mazumder, 2011;Simon et al, 2013). 13…”

A Possible Explanation of the Missing Deflation Puzzle

“…However, the failure of these models to forecast behavior of inflation and other key macroeconomic variables following the 2008 Great Recession has been interpreted as an evidence against this class of models. Two important papers in this regard are Ball and Mazumder () and Hall (). Ball and Mazumder make their point by forecasting inflation for the period between 2008 and 2010 using the New Keynesian Phillips Curve (NKPC), which determines inflation in these models.…”