Understanding the inflation–output relationship across business cycle phases

Roberto A. De Santis and Dario Cardamone

No 3175, Working Paper Series from European Central Bank

Abstract: We examine the state dependence of monetary policy transmission and the parameters of the Phillips curve, dynamic IS equation, and Taylor rule across four regimes defined by joint deviations of inflation from the Federal Reserve’s target and output from potential. The analysis uncovers important regime-specific asymmetries. The Taylor principle holds across all four regimes. The systematic policy response to the output gap weakens when inflation is below target but output remains above potential, whereas the response to inflation is broadly similar across regimes. The size of monetary policy shocks is significantly larger when inflation exceeds its target. The Phillips curve steepens when inflation exceeds target and output is above potential, while output sensitivity to interest rate changes declines under high inflation and economic slack. This explains why monetary policy shocks are significantly larger in inflationary booms, but transmission becomes less effective when elevated inflation coincides with economic slack. JEL Classification: C32, E52

Keywords: DIS curve; monetary transmission; Phillips curve; state dependence; Taylor rule; threshold VAR (search for similar items in EconPapers)
Date: 2026-01
New Economics Papers: this item is included in nep-inv and nep-mon
Note: 185689
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