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Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations

Brent Bundick () and Andrew Smith ()

No RWP 20-11, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: In a macroeconomic model with drifting long-run inflation expectations, the anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better-anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the United States but failed to anchor expectations in Japan. Moreover, the improved anchoring of U.S. inflation expectations can account for much of the observed flattening of the Phillips curve. Finally, we present evidence that initial Federal Reserve communication around its longer-run inflation objective may have led inflation expectations to anchor at a level below 2 percent.

Keywords: Monetary policy; Inflation; Inflation targeting; Central bank communication; Structural breaks; Phillips Curve (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Pages: 40
Date: 2020-09-03
New Economics Papers: this item is included in nep-cba, nep-env, nep-mac and nep-mon
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DOI: 10.18651/RWP2020-11

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