It's Baaack: The Surge in Inflation in the 2020s and the Return of the Non-Linear Phillips Curve

Pierpaolo Benigno and Gauti Eggertsson

No 18116, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We develop a New Keynesian model with search-and-matching frictions that microfounds a nonlinear inverse-L (Inv-L)) Phillips curve. The model yields a piecewise-linear relationship whose kink is defined by a time-varying Beveridge threshold in labor-market tightness, (theta_t = v_t/u_t). When tightness exceeds this threshold, the Phillips-curve slope and the pass-through of supply shocks rise sharply, providing a mechanism for the post-pandemic inflation surge and its subsequent moderation without a deep recession. Using U.S. quarterly data from 1960 to 2024, we estimate the inverse-L Phillips curve implied by the model and identify the threshold empirically near unity. Above this point, labor-market tightness and supply disturbances exert strong, statistically significant effects on inflation, while below it their impact is muted. The results help explain why policymakers and forecasters underestimated the magnitude of the recent inflation surge. More generally we propose a unified framework to understanding all six U.S. inflation surges since the establishment of the Federal Reserve (five via labor shortage, one via expectations).

Date: 2023-04
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Working Paper: It’s Baaack: The Surge in Inflation in the 2020s and the Return of the Non-Linear Phillips Curve (2023)
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