Variation in the Phillips Curve Relation across Three Phases of the Business Cycle
Richard Ashley () and
Randal Verbrugge ()
No 190900, Working Papers from Federal Reserve Bank of Cleveland
We use recently developed econometric tools to demonstrate that the Phillips curve unemployment rate–inflation rate relationship varies in an economically meaningful way across three phases of the business cycle. The first (“bust phase”) relationship is the one highlighted by Stock and Watson (2010): A sharp reduction in inflation occurs as the unemployment rate is rising rapidly. The second (“recovery phase”) relationship occurs as the unemployment rate subsequently begins to fall; during this phase, inflation is unrelated to any conventional unemployment gap. The final (“overheating phase”) relationship begins once the unemployment rate drops below its natural rate. We validate our findings in a forecasting exercise and find statistically significant episodic forecast improvement. Our analysis allows us to provide a unified explanation of many prominent findings in the literature.
Keywords: overheating; recession gap; persistence dependence; NAIRU (search for similar items in EconPapers)
JEL-codes: C22 C32 E00 E31 E5 (search for similar items in EconPapers)
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Working Paper: Mis-Specification in Phillips Curve Regressions: Quantifying Frequency Dependence in This Relationship While Allowing for Feedback (2006)
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