Will US inflation awake from the dead? The role of slack and non-linearities in the Phillips curve

Bruno Albuquerque and Ursel Baumann

Journal of Policy Modeling, 2017, vol. 39, issue 2, 247-271

Abstract: The response of US inflation to the high levels of spare capacity during the Great Recession of 2007–09 was rather muted. At the same time, some have argued that the short-term unemployment gap has a more prominent role than the standard unemployment gap in determining inflation, and either the closing of this gap or non-linearities in the Phillips curve could lead to a sudden pick-up in inflation. In this context, our main aim is to provide guidance to policymakers as regards the reliability of the Phillips curve to forecast inflation. Our main findings from Phillips curves estimated since the early-1990s suggest that the consideration of a time-variation in the Phillips curve slope is more relevant than just focusing on finding the “correct” slack measure. Although the Phillips curve may be relatively flat over the full sample (1992Q1–2015Q1), time-varying estimates with rolling windows and with the Kalman filter suggest that the slope does vary over time and that it has increased slightly since 2013. These non-linear specifications outperform the benchmark linear model in an out-of-sample exercise. The main policy implication is that decision-makers should not exclude the possibility that inflation might rise suddenly given its non-linear behaviour, and more strongly than a linear model would dictate.

Keywords: Phillips curve; Labour market slack; Inflation dynamics; Forecasting (search for similar items in EconPapers)
JEL-codes: E31 E37 E58 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (23)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jpolmo:v:39:y:2017:i:2:p:247-271

DOI: 10.1016/j.jpolmod.2017.01.004

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