Inflation Expectations and Nonlinearities in the Phillips Curve

28 Pages Posted: 16 Nov 2017 Last revised: 17 Nov 2017

See all articles by Alexander Doser

Alexander Doser

Federal Reserve Banks - Federal Reserve Bank of Boston

Ricardo Cavaco Nunes

Federal Reserve Banks - Federal Reserve Bank of Boston

Nikhil Rao

Federal Reserve Banks - Federal Reserve Bank of Boston

Viacheslav Sheremirov

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: 2017-10-01

Abstract

This paper shows that a simple form of nonlinearity in the Phillips curve can explain why, following the Great Recession, inflation did not decrease as much as predicted by linear Phillips curves, a phenomenon known as the missing disinflation. We estimate a piecewise-linear specification and document that the data favor a model with two regions, with the response of inflation to an increase in unemployment slower in the region where unemployment is already high. Nonlinearities remain important, even when we account for other factors proposed in the literature, such as consumer expectations of inflation or financial frictions. However, studying a range of specifications with different measures of inflation and economic activity, we conclude that, in most cases, consumer expectations are more robust than nonlinearities. We find that the role of consumer expectations was especially important in the 1970s and ’80s, during a turbulent rise in inflation followed by the Volcker disinflation; the nonlinearities make disinflation more problematic and require the inflation expectations process to be more forward-looking during this period, thereby putting a larger weight on survey expectations. We conclude that a nonlinear Phillips curve with forward-looking survey expectations can be a useful tool to understand inflation dynamics during episodes of rapid disinflation and persistent inflation.

Keywords: inflation expectations, Phillips curve, Volcker disinflation

JEL Classification: D84, E24, E31, E32

Suggested Citation

Doser, Alexander and Nunes, Ricardo Cavaco and Rao, Nikhil and Sheremirov, Viacheslav, Inflation Expectations and Nonlinearities in the Phillips Curve (2017-10-01). FRB of Boston Working Paper No. 17-11. Available at SSRN: https://ssrn.com/abstract=3072265

Alexander Doser (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston

Ricardo Cavaco Nunes

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

Nikhil Rao

Federal Reserve Banks - Federal Reserve Bank of Boston

600 Atlantic Avenue
Boston, MA 02210
United States

Viacheslav Sheremirov

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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