The Hard Road to a Soft Landing: Evidence from a (Modestly) Nonlinear Structural Model

Abstract

What drove inflation so high in 2022? Can it drop rapidly without a recession? The Phillips curve is central to the answers; its proper (nonlinear) specification reveals that the relationship is strong and frequency dependent, and inflation is very persistent. We embed this empirically successful Phillips curve – incorporating a supply-shocks variable – into a structural model. Identification is achieved using an underutilized data-dependent method. Despite imposing anchored inflation expectations and a rapid relaxation of supply-chain problems, we find that absent a recession, inflation will be more than 3 percent by the end of 2025. A simple welfare analysis supports a mild recession as preferred to an extended period of elevated inflation, under a typical loss function

Post-COVID Inflation Dynamics: Higher for Longer

“…The first is the PPI for core intermediate goods, denoted PPI. Verbrugge and Zaman (2023) find that PPI captures supply price pressures and is an important determinant of trimmed-mean PCE inflation. The next three variables are also inflationspecific, corresponding to the tripartite decomposition of Chair Powell.…”

“…7 The approach to filtering is described in Appendix A. Following Verbrugge and Zaman (2023), these components of the unemployment rate are derived from the jobless unemployment rate of Hall 6 The bias-adjustment procedure is informed by estimating two separate AR(1) processes on the historical wedge (i.e., the gap between the two series) and using the estimated processes to compute the estimates of the time-varying wedge over the forecast period. One of the AR(1) processes is estimated over the entire sample, based upon a 12month moving average of the monthly series; the other one is estimated over the post-1985 sample (with an intercept change in 2010), based upon a 3-month moving average of the monthly series, resulting in two forecasts of the timevarying wedge that are averaged to construct a single series of the wedge.…”

“…Our specification largely follows Verbrugge and Zaman (2023). We are ultimately interested in reliable forecasts, so model parsimony was a chief consideration.…”

“…In each equation, we allow up to 5 quarterly lags in the dependent variable and up to 4 quarterly lags in each of the other variables. Allowing for the fifth lag is quite important for accurately assessing the persistence of each series, as demonstrated in Verbrugge and Zaman (2023).…”

“…In this paper, we use this tripartite decomposition of core PCE inflation to explore the path of inflation going forward. 1 We build upon recent work by Ashley and Verbrugge (2022a) and Verbrugge and Zaman (2023) -two studies providing compelling evidence in favor of a nonlinear Phillips curve -to construct a nonlinear structural vector autoregression (SVAR), a model suitable for exploring counterfactual conditional inflation forecasts. We estimate our model over the 1985-2019 period and identify it using the data-determined method of Swanson and Granger (1997), which substantially reduces the role of subjective elements.…”