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The Hibernating Phillips Curve - February 26, 2019

“Reports of the death of the Phillips curve may be greatly exaggerated”

Mixing metaphors and borrowing from a Mark Twain misquote is an ominous way to start any academic paper, but in the case of “Prospects for Inflation in a High Pressure Economy: Is the Phillips Curve Dead or is It Just Hibernating?”, the ensuing analysis is anything but sophomoric. The paper, by Peter Hooper of Deutsche Bank, Frederic Mishkin of Columbia University, and Amir Sufi of the University of Chicago, seeks to answer the titular question and surely delivers.

“As the empirical evidence in this paper indicates, the Phillips curve could be hibernating, and there is a risk of the Phillips curve waking up, with inflationary pressures rising in the face of an overheating labor market”.

They explain the observation that the price Phillips curve has been dormant since the 1980s could be a result of Fed behavior. “Since the 1980s, the Fed focused much more on avoiding labor market overheating in order to stabilize inflation.” This had the consequence that “the post-1988 Phillips curve may not be able to reveal... nonlinearities because there are so few observations of very tight labor markets since 1988”.

On the wage side of the equation, their evidence “suggests that the wage-Phillips curve is alive and well”:

“While the wage Phillips curve may have flattened some over time, it remains much steeper and evidence of nonlinearities much more robust than for the price Phillips curve in the post-1988 sample period.”

In addition to analysis of the events that lead to inflation 1960s and beyond, the authors warn that the economy can switch to a nonstationary regime, “in which shocks to inflation have persistent effects and inflation expectations become unanchored”. By using the 1960s as a parallel, “there is a possibility that we could move to a nonstationary regime if the unemployment rate stays well below the natural rate of unemployment for a long period of time”. Should that happen, their models forecast between 2.75% and 4.25% inflation growth. They caution that the Fed should “monitor what is happening in wage inflation, if its continual rise suggests that this might lead to price inflation down the road.” What, me worry?