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I would like to thank Oya Celasun, Ajai Chopra, Peter Doyle, Zeno Enders, Dora Iakova, Charles Kramer, Wes McGrew, and Ola Melander for very helpful comments. All remaining errors are my own responsibility.
A high weight on the forward-looking term is reported, among others, by Galí and Gertler (1999), Sbordone (2002), Galí et al. (2005), and Kleibergen and Mavroeidis (2008), but not by Fuhrer and Moore (1995), Fuhrer (1997), and Rudd and Whelan (2005a).
The finding of a reduced slope coefficient is not uncontroversial, however. Nason and Smith (2008), for example, find no evidence for a parameter change in US inflation dynamics since 1955.
Laxton et al. (1995) and Turner (1995) are examples of such research, focusing on nonlinearities in the link between output gaps and inflation. The authors find that positive output gaps have a greater effect on inflation than negative ones, consistent with a convex Phillips curve.
However, Rudd and Whelan (2005b) provide evidence suggesting that the labor share does not improve the empirical fit of the NKPC at all.
Data for the OECD’s Economic Outlook No. 87 were released in June 2010, after most of the analysis in this paper had been completed. However, we still use the June 2010 dataset in Section VI below, which deals with the most recent, post-2007 period and hence is most prone to data revisions.
By contrast, the average quarterly change in inflation in the remainder of our sample is marginally positive.
It is not clear from the discussion in the literature whether this finding alone meets the definition of a flatter Phillips curve. Indeed, most of the theoretical work focuses on inflation dynamics around a zero-rate equilibrium, in which percent changes and percentage point changes coincide. In empirical applications, the interpretation depends on whether the Phillips curve is specified in terms of simple inflation rates or in log terms. In the latter case, the focus is on relative, rather than absolute changes in inflation, and our finding of broadly proportional disinflation during PLOG episodes would signal no flattening of the Phillips curve at all.
The pre-1990 subsample contains 14 observations, the post-1990 subsample 10. Denmark’s 1989–92 PLOG episode is excluded from both.
Even for Japan, de Veirman (2009) has emphasized the remarkable fact that deflation has proven very sticky at low rates, rather than accelerating over time.
There are a few PLOG episodes from before the pervasive monetary policy reforms of the 1990s—i.e., a move to greater central bank independence and inflation targeting—where inflation nonetheless bottomed out at the same 2-3 percent. The list of countries (Germany and the Netherlands) suggests, however, that these were precisely cases in which central banks already enjoyed a high degree of credibility even in the 1980s.
In principle, the two hypotheses could be distinguished by their implications for times of positive output gaps: the credibility hypothesis implies symmetric insensitivity of inflation, while downward rigidities do not.
Another, purely statistical argument why the change in the output gap may be found to matter for inflation is highly persistent measurement error in output gap levels. See Orphanides et al. (2000) and Walsh (2003).
It also implies, however, that we have to exclude the Japanese episode of 2001–03 (which started from a negative inflation rate) to ensure a consistent interpretation. Figure 13, by contrast, includes all episodes.
Although not shown here, we also obtain the expected relationship when we consider the change in oil price inflation (rather than the oil price level) between the final pre-episode year and the final year of the episode.
Considering real ULC instead, we find a marked negative difference between unusual and typical quarters, driven entirely by the fact that the real ULC variable includes the CPI in the denominator. With relatively limited movements in nominal ULC in a given quarter, the change in inflation dominates the dynamics of real ULC, generating a strong negative correlation with contemporaneous inflation.
An interesting separate question is in what way policymakers should take the uncertainty around current assessments and forecasts into account when making policy plans.
While data for the output gap include forecasts through end-2011, we show only actual outturns for all other variables. Moreover, we impose a balanced sample requirement, so as to avoid trends being distorted by changes in sample composition. Thus the length of the series shown is constrained by the episode with the most limited data availability.
Needless to say, certain fiscal measures, notably indirect tax hikes, could temporarily raise inflation, even if their macroeconomic effect is contractionary.