Why Has Inflation Been So Unresponsive to Economic Activity in Recent Years?

No 920, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: Standard Phillips curve models relating price inflation to measures of slack in the economy suggest that the United States should have experienced an episode of deflation during the Great Recession and the subsequent sluggish recovery. But although inflation reached very low levels, prices continued to rise rather than fall. More recently, many observers have argued that inflation should have increased as the unemployment rate declined and labor markets tightened, but inflation has remained below the Federal Reserve’s policy target. This paper confirms that the slope of the Phillips curve has decreased over recent decades and is very close to zero today. I modify the Phillips curve to allow its slope to vary continuously through time drawing on theories of price-setting behavior when prices are costly to adjust and when information is costly to obtain. I find that adapting the Phillips curve to allow for time-variation in its slope helps explain inflation before, during, and after the Great Recession.

Keywords: Inflation; Phillips curve; Great Recession (search for similar items in EconPapers)
JEL-codes: E30 E31 (search for similar items in EconPapers)
Date: 2016-04-30
New Economics Papers: this item is included in nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:boc:bocoec:920

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