Inflation Dynamics and the Great Recession
This paper examines inflation dynamics in the United States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960-2007 are used to predict inflation over 2008-2010: inflation should have fallen by more than it did. We resolve this puzzle with two modifications of the Phillips curve, both suggested by theories of costly price adjustment: we measure core inflation with the median CPI inflation rate, and we allow the slope of the Phillips curve to change with the level and variance of inflation. We then examine the hypothesis of anchored inflation expectations. We find that expectations have been fully "shock-anchored" since the 1980s, while "level anchoring" has been gradual and partial, but significant. It is not clear whether expectations are sufficiently anchored to prevent deflation over the next few years. Finally, we show that the Great Recession provides fresh evidence against the New Keynesian Phillips curve with rational expectations.
This is a revised version of a paper that was prepared for the March 2011 Brookings Panel on Economic Activity. We are grateful for excellent research assistance from Indra Astrayuda, Kue Peng Chuah, Xu Lu, Prathi Seneviratne, and Hou Wang, and for suggestions from the editors, Karen Dynan, Jon Faust, Robert Gordon, Jeremy Rudd, James Stock, Eric Swanson, Jonathan Wright, and participants at the Brookings Panel. We are also very grateful to Brent Meyer for assistance with the Cleveland Fed's data on inflation. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Laurence Ball & Sandeep Mazumder, 2011. "Inflation Dynamics and the Great Recession," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(1 (Spring), pages 337-405. citation courtesy of