The L-Shaped Phillips Curve: Theoretical Justification and Empirical Implications

52 Pages Posted: 6 Dec 2017

See all articles by Narayana Kocherlakota

Narayana Kocherlakota

University of Minnesota - Twin Cities - Department of Economics

Date Written: November 2017

Abstract

This paper has two parts. In the first part, I demonstrate that, in the absence of price and wage bounds, monetary models do not have current equilibria - and so lack predictive content - for a wide range of possible policy rules and/or beliefs about future equilibrium outcomes. This non-existence problem disappears in models in which firms face (arbitrarily loose) finite upper bounds on prices or positive lower bonds on nominal wages. In the second part, I study the properties of a class of dynamic monetary models with these kinds of bounds on prices/wages. Among other results, I show that these models imply that the Phillips curve is L-shaped, are consistent with the existence of permanently inefficiently low output (secular stagnation), and do not imply that forward guidance is surprisingly effective. I show too that economies with lower nominal wage floors have even worse equilibrium outcomes in welfare terms. It follows that models with arbitrarily low but positive nominal wage floors are not well approximated by models without wage floors.

Suggested Citation

Kocherlakota, Narayana, The L-Shaped Phillips Curve: Theoretical Justification and Empirical Implications (November 2017). NBER Working Paper No. w24086. Available at SSRN: https://ssrn.com/abstract=3082269

Narayana Kocherlakota (Contact Author)

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States
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612-624-0209 (Fax)

HOME PAGE: http://www.econ.umn.edu/~nkocher/

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