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The hockey stick Phillips curve and the effective lower bound

Gregor Böhl and Philipp Lieberknecht

No 55/2021, Discussion Papers from Deutsche Bundesbank

Abstract: We show that if business cycles are driven by financial shocks, the interplay between the effective lower bound (ELB) and the costs of external financing can generate an additional supply-side channel, which causes a disconnect between inflation and output. In normal times, factor costs dominate firms' marginal costs and hence inflation; credit spreads and the nominal interest rate, which together constitute external financing costs, balance out in response to a financial shock. When nominal rates are constrained by the ELB, larger spreads can partly offset the effect of lower factor costs on firms' price setting. The Phillips curve is hence flat at the ELB, but features a positive slope in normal times and thus an overall hockey stick shape. This mechanism also weakens the effects of forward guidance on inflation, since such policy reduces spreads and thereby financing costs.

Keywords: Phillips curve; financial frictions; effective lower bound; disinflation; forward guidance (search for similar items in EconPapers)
JEL-codes: C62 C63 E31 E32 E44 E52 E58 E63 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-cwa, nep-mac and nep-mon
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