The Phillips Curve: Price Levels or Real Exchange Rates?

François Geerolf

No 1187, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper argues that the Phillips Curve is driven by a correlation between real exchange rates and economic activity, which implies a correlation between inflation and economic activity in fixed exchange rate regimes. According to this interpretation, the Phillips Curve is a correlation between relative prices and economic activity, and does not result from a monetary phenomenon. Three new facts are put forward to support that hypothesis. First, the original Phillips relation is valid in fixed exchange rate regimes, including across regions of the same country, and becomes flatter as the exchange rate regime moves continuously from fixed to floating. Second, when nominal or real exchange rates are used in place of inflation, the Phillips relation is restored in floating exchange rate regimes. Third, identified aggregate demand shocks (such as tax cuts) drive a positive relation between real exchange rates and economic activity in the reduced form. A textbook international finance model is developed to help rationalize these findings. This hypothesis implies that the US Phillips Curve broke down in the 1970s following the collapse of the Bretton Woods system.

Date: 2018
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:1187

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