Phillips Curve -- Median Inflation & Output Gap Co-Movement
Since early 2010 my colleagues Jan Bruha, Sermat Solhaz, and I have been working provide the evidence about the "Phillips Curve".
The short-term Phillips curve is a theoretical and empirical concept suggesting that when the economy inters a slack, and the output gap \(\hat{Y}_t\) declines, the inflation decelerates and deviates from the target:
\[\pi_t = \bar{\pi_t} + \alpha \widehat{y}_{t-1}. \]
In the papers below we provide evidence for the Phillips curve for the Euro Area, for the United States, and for selected OECD countries. The papers below range from agnostic non-parametric statistical methods, through state-space filters, to DSGE models with forward-looking expectations.
There are two important ingredients to detect the Phillips curve relationship:
Papers, Models, and Slides:
The short-term Phillips curve is a theoretical and empirical concept suggesting that when the economy inters a slack, and the output gap \(\hat{Y}_t\) declines, the inflation decelerates and deviates from the target:
\[\pi_t = \bar{\pi_t} + \alpha \widehat{y}_{t-1}. \]
In the papers below we provide evidence for the Phillips curve for the Euro Area, for the United States, and for selected OECD countries. The papers below range from agnostic non-parametric statistical methods, through state-space filters, to DSGE models with forward-looking expectations.
There are two important ingredients to detect the Phillips curve relationship:
- The link between output cycle exists for inflation deviation from its long-run expectations, or from its inflation target. Demeaning the inflation is not enough, as in most countries the inflation target or long-term inflation expectations have not been constant in the past.
- It helps using median inflation (trimmed-mean inflation) as a measure of demand-driven inflation. The headline inflation is not only affected heavily by oil prices but it is highly volatile. Median inflation, unlike mean inflation, down-weights the role of extreme price changes, which are usually due to the changes in relative prices and help hiding the inflation signal.
Papers, Models, and Slides:
- Inflation and output co-movement in the euro area: Love at second sight? (2013) [pdf], (joint with Jan Brůha and Serhat Solmaz), IMF Working Paper WP/13/192. In this paper we illustrate that a well-defined Phillips curve exists in the euro area. The key ingredient to see the Phillips curve is the use of the "median inflation" or trimmed-mean inflation to filter out the outliers deal with the fat tails of the price growth distribution. We provide both time-domain and frequency-domain evidence about a healthy Phillips curve in the Euro Area.
An "Inflation monitoring toolbox" has been used since 2013 to monitor the inflation development in the EA and the member countries, remaining EU countries, and selected OECD countries. An example report for the euro area is here [pdf].
The data underlying this paper and their update were provided to Lawrence Ball and Sandeep Mazumder, upon their request, for their work on the Phillips curve for the Euro Area, confirming our conclusions from 2013. (Lawrence Ball following our approach [pdf])
- Output and Inflation Co-Movement: An Update on Business-Cycle Stylized Facts [pdf] (Dec 2016, joint with J. Bruha and S. Solmaz), IMF Working Paper WP/16/241. In the paper, we review business stylized facts about real and nominal co-movement. We argue there is a strong and rather stable co-movement of real variables among themselves and also co-movement of real output with output inflation dynamics around their long-term expectations. The paper also shows that for OECD countries there is a close co-movement between the output cycle and the deviation of median inflation from the inflation target, suggesting a Phillips Curve relationship.
- Cheers to the good health of the US short-run Phillips Curve: 1960 -- 2012, draft [pdf], [slides, Notre Dame, Midwest Macro] The paper document strong output and inflation co-movement in the US, using spectral measures. Statistical and economic arguments are used to define a measure of inflation target in the US. A simple New Keynesian DSGE model built fits inflation dynamics using demand shocks.[Here] you can find some simple graphs demonstrating that despite, or due to, active monetary policy there is a tight link between output and inflation in the United states. This was an early paper that never
- Learning about Monetary Policy using VARs? Some Pitfalls and Solutions (with Jan Bruha), [slides] This is a lecture about using trend-cycle VARs and the importance of variable transformations. One of the transformations is the need to model inflation as a deviation from its often time-varying inflation target, or from its long-run expectations (for the US).
