EMPIRICAL ASSESSMENT OF THE PHILLIPS CURVE

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1 EMPIRICAL ASSESSMENT OF THE PHILLIPS CURVE Emi Nakamura Jón Steinsson Columbia University January 2018 Nakamura-Steinsson (Columbia) Phillips Curve January / 55

2 BRIEF HISTORY OF THE PHILLIPS CURVE Phillips 58 points out empirical relationship between wage inflation and unemployment in UK Samuelson-Solow 60 popularize idea in US Nakamura-Steinsson (Columbia) Phillips Curve January / 55

3 hypothesis stated above is correct the rise in import prices in 1862 may just have been sufficient to start up a mild wage-price spiral, but in the remainder of the period changes in import prices will have had little or no effect on the rate of change of wage rates. INFLATION AND UNEMPLOYMENT IN THE UK U 0 cf. cl) E? 2-0 0~~~~ 0? -2. ~~~~~~~~~~* Source: Phillips (1958) $ Unemptoyment, %. Fig,t Nakamura-Steinsson (Columbia) Phillips Curve January / 55

4 INFLATION AND UNEMPLOYMENT IN THE UK 286 ECONOMICA [NOVEMBER 10 X. *-,Curve fitted to data 6- IV c 2 E: 2- t-t 2 > ~~~~~62-2 z ~~~~~~~~~67 I I I * a I I I I I B Unemployment, %. Source: Phillips (1958) Fig Nakamura-Steinsson (Columbia) Phillips Curve January / 55

5 Unemployment, %. Fig INFLATION AND UNEMPLOYMENT IN THE UK 2 Curve fitted to data c) 0 3: 4l C 73 Z'% 70 0 Unmpoyen,74. Fig ~ ~ ~ 7 Source: Phillips (1958) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

6 INFLATION 288 AND ECONOMICA UNEMPLOYMENT [NOVEMBER IN THE UK C t1: 10- -f1c Curve fitted to data +' 6 \ 06 0) 3 4 \9 o 90 E )C I cr. Unemptoyment, %. Fig Source: Phillips (1958) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

7 cr. Unemptoyment, %. Fig INFLATION AND UNEMPLOYMENT IN THE UK ># * \ Curve fitted to data (U4 no4- \ 0 0 E ~~~~~01 02 os X-2- "o -4J Unemployment, 1. Source: Phillips (1958) Fig Nakamura-Steinsson (Columbia) Phillips Curve January / 55

8 US MACRO POLICY IN THE 1960S Phillips curve viewed as a menu of options Policy makers can lower unemployment if they are willing to tolerate more inflation Nakamura-Steinsson (Columbia) Phillips Curve January / 55

9 INFLATION AND U.S. UNEMPLOYMENT in the 1960 s IN THE US Inflation Rate Unemployment Rate 46 Nakamura-Steinsson (Columbia) Phillips Curve January / 55

10 FRIEDMAN AND PHELPS MAKE A PREDICTION Friedman 68 and Phelps 67: Policymakers cannot exploit a stable Phillips curve forever Workers will demand wage increases in excess of expected inflation As inflation rises, expectations of inflation will rise Changes in expected inflation will shift the Phillips curve Nakamura-Steinsson (Columbia) Phillips Curve January / 55

11 INFLATION AND U.S. UNEMPLOYMENT in the 1960 s IN THE US Inflation Rate Unemployment Rate 46 Nakamura-Steinsson (Columbia) Phillips Curve January / 55

12 FRIEDMAN Friedman ANDand PHELPS Phelps WERE RIGHT! Were Right!! Inflation Rate Unemployment Rate 9 Nakamura-Steinsson (Columbia) Phillips Curve January / 55

13 MODERN PHILLIPS CURVE Three drivers of inflation: Expected inflation: E t π t π t = βe t π t+1 + κ(y t y n t ) + η t Output relative to potential: y t y n t Cost-push shocks: η t Specific form above based on Calvo 83 sticky-price assumptions But details may vary (e.g., sticky information yields Ēt 1π t ) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

14 ESTIMATING SLOPE OF THE PHILLIPS CURVE π t = βe t π t+1 + κ(y t y n t ) + η t Object of interest: Slope coefficient κ How much does an increase in demand / tightness / output gap affect inflation Nakamura-Steinsson (Columbia) Phillips Curve January / 55

15 ESTIMATING SLOPE OF THE PHILLIPS CURVE π t = βe t π t+1 + κ(y t y n t ) + η t Object of interest: Slope coefficient κ How much does an increase in demand / tightness / output gap affect inflation Tricky identification issues: Expected inflation unobserved Natural rate of output (i.e., supply shocks) unobserved Cost push shocks (e.g., variation in desired markups) unobserved All three may cause omitted variables bias Nakamura-Steinsson (Columbia) Phillips Curve January / 55

16 EXPECTED INFLATION Pre Friedman/Phelps Phillips curve: Change in output gap needed to change inflation Same is true for accelerationist Phillips curve (i.e., Phillips curve with adaptive expectations) π t = π t 1 + κ(y t y n t ) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

17 EXPECTED INFLATION Pre Friedman/Phelps Phillips curve: Change in output gap needed to change inflation Same is true for accelerationist Phillips curve (i.e., Phillips curve with adaptive expectations) π t = π t 1 + κ(y t y n t ) Sargent 82: Hyperinflations end abruptly with little or no output cost Clear violation of aforementioned Phillips curves Nakamura-Steinsson (Columbia) Phillips Curve January / 55

18 GERMAN HYPERINFLATION Sargent (1982): The Ends of Four Big Inflations Source: Sargent (1982) 9 Nakamura-Steinsson (Columbia) Phillips Curve January / 55

19 EXPECTED INFLATION In Calvo model, perfectly credible, unexpected disinflation can occur without any affect on output gap Expected inflation does all the work Theoretical victory: Potential explanation for Sargent facts Nakamura-Steinsson (Columbia) Phillips Curve January / 55

20 EXPECTED INFLATION In Calvo model, perfectly credible, unexpected disinflation can occur without any affect on output gap Expected inflation does all the work Theoretical victory: Potential explanation for Sargent facts Empirical headache: Movements in inflation potentially completely unrelated to output gap Even if output gap moves during disinflation, not clear what fraction of disinflation was due to shift in expected inflation Measurement of expected inflation crucial but hard Nakamura-Steinsson (Columbia) Phillips Curve January / 55

21 SUPPLY SHOCKS Slope of Phillips curve: Causal effect of output gap on inflation But output gap is not directly observable Ideal experiment: Shifts in output holding potential output and expected inflation constant Nakamura-Steinsson (Columbia) Phillips Curve January / 55

22 SUPPLY SHOCKS Slope of Phillips curve: Causal effect of output gap on inflation But output gap is not directly observable Ideal experiment: Shifts in output holding potential output and expected inflation constant Shifts in potential output (or natural rate of unemployment): Shift the Phillips curve Potentially lead to negative correlation between output and inflation Bias estimated slope of Phillips curve downward Cost push shocks cause similar problems Nakamura-Steinsson (Columbia) Phillips Curve January / 55

23 IS THE PHILLIPS CURVE DEAD? Phillips curve often pronounced dead Many economists think Phillips curve is an empirical disaster Prominent episodes: Missing inflation in late 1990s Missing disinflation in the Great Recession Let s take a closer look Nakamura-Steinsson (Columbia) Phillips Curve January / 55

24 STAGFLATION OF THE 1970S Inflation Unemployment Nakamura-Steinsson (Columbia) Phillips Curve January / 55

25 STAGFLATION OF THE 1970S Friedman and Phelps were right: Phillips curve shifted up in 1970s But why did inflation rise at higher and higher unemployment rates as 1970s progressed? Possible explanation: Rise in natural rate of unemployment Baby boon generation was entering labor force in 1970s Nakamura-Steinsson (Columbia) Phillips Curve January / 55

26 VOLCKER DISINFLATION Inflation Unemployment Nakamura-Steinsson (Columbia) Phillips Curve January / 55

27 MISSING INFLATION IN LATE 1990S Inflation Unemployment Nakamura-Steinsson (Columbia) Phillips Curve January / 55

28 MISSING INFLATION IN LATE 1990S : Looks good : Why doesn t inflation rise? Maybe it was just starting to in 2000 but Fed nipped it in the bud Maybe the Phillips curve is highly non-linear Nakamura-Steinsson (Columbia) Phillips Curve January / 55

29 MISSING DISINFLATION IN THE GREAT RECESSION Inflation Unemployment Nakamura-Steinsson (Columbia) Phillips Curve January / 55

30 MISSING DISINFLATION IN THE GREAT RECESSION Inflation Unemployment Nakamura-Steinsson (Columbia) Phillips Curve January / 55

31 IS THE PHILLIPS CURVE DEAD? Why did inflation not fall more in Great Recession? Actually rose in 2010 and 2011 Why is inflation not rising now? Nakamura-Steinsson (Columbia) Phillips Curve January / 55

32 COIBION-GORODNICHENKO 15 Is the Phillips Curve Alive and Well after All? Focus on missing disinflation during Great Recession Population explanations insufficient Anchored inflationary expectations Movements in natural rate Flattening of the Phillips curve Nakamura-Steinsson (Columbia) Phillips Curve January / 55

33 COIBION-GORODNICHENKO 15 Is the Phillips Curve Alive and Well after All? Focus on missing disinflation during Great Recession Population explanations insufficient Anchored inflationary expectations Movements in natural rate Flattening of the Phillips curve New explanation: Household inflation expectations rose in If firm s expectation the same, this can explain missing disinflation Nakamura-Steinsson (Columbia) Phillips Curve January / 55

34 COIBION-GORODNICHENKO 15 π t = βe t π t+1 + κ(y t y n t ) + η t Baseline assumptions: Output gap measure: Unemployment rate y t y n t = u t Expectations of inflation: backward looking Ignore discounting: β = 1 E t π t+1 = 1 4 (π t 1 + π t 2 + π t 3 + π t 4 ) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

35 COIBION-GORODNICHENKO 15 π t Eπ Back t+1 = κu t + η t Estimate by OLS for sample 1960Q1-2007Q4 Implicitly assuming that η t u t Similar to VAR timing restriction. (Why?) Consider whether Great Recession conforms with earlier relationship Nakamura-Steinsson (Columbia) Phillips Curve January / 55

36 MISSING DISINFLATION 202 AMERICAN ECONOMIC JOURNAL: MACROECONOMICS JANUARY 2015 Panel A. CPI inflation and US unemployment 4 09Q3 09Q4 π t Eπ t Back Q4 08Q1 08Q2 08Q3 12Q4 12Q3 13Q1 12Q1 12Q2 11Q4 11Q1 11Q2 09Q2 10Q4 11Q3 10Q3 10Q1 10Q2 4 09Q Unemployment rate Source: Coibion and Gorodnichenko (2015) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

37 MISSING DISINFLATION Unemployment rate Panel B. CPI inflation and predicted inflation from the Phillips Curve Inflation Actual Backward PC Figure 1. The Missing Disinflation Source: Coibion and Gorodnichenko (2015) Notes: Panel A shows the scatter plot of inflation surprises ( π t E t π BACK t ) versus unemployment rate. E t π BACK Nakamura-Steinsson (Columbia) Phillips Curve January 2018 t 32 is / 55

38 MISSING DISINFLATION 204 AMERICAN ECONOMIC JOURNAL: MACROECONOMICS JANUARY 2015 Panel A. PCE inflation Panel B. GDP deflator inflation BACK π t Eπ t PCE inflation Q4 08Q1 08Q2 08Q3 11Q1 11Q2 09Q3 09Q4 12Q3 13Q1 09Q2 10Q4 12Q4 12Q1 11Q3 10Q1 10Q3 10Q2 11Q4 12Q2 09Q1 π t Eπ t BACK GDP deflator inflation Q2 08Q1 07Q4 08Q3 12Q3 10Q2 10Q1 09Q4 11Q2 11Q3 10Q3 12Q1 11Q1 10Q4 13Q1 12Q4 12Q2 09Q3 09Q1 11Q4 09Q Unemployment rate Unemployment rate Panel C. Core CPI inflation Panel D. Core PCE inflation Source: Coibion and Gorodnichenko (2015) Q4 2 11Q2 07Q4 11Q1 11Q2 11Q3 07Q4 08Q1 08Q2 12Q1 11Q3 11Q109Q2 09Q3 08Q1 08Q3 09Q2 09Q4 0 10Q2 13Q1 12Q2 12Q1 11Q4 10Q3 08Q3 13Q1 12Q412Q2 10Q1 11Q4 12Q4 09Q1 10Q4 12Q3 0 10Q3 10Q4 08Q2 12Q3 09Q3 10Q2 09Q1 08Q4 10Q1 2 2 Nakamura-Steinsson (Columbia) Phillips Curve 4 January / 55 t Eπ BACK t CORE inflation BACK t Eπ t CORE inflation

39 BA π t Eπ t PCE inflati Q2 09Q1 MISSING DISINFLATION Q1 12Q3 13Q1 09Q2 10Q4 12Q4 12Q1 11Q3 10Q1 10Q3 10Q2 11Q4 π t Eπ t BAC GDP deflator in Q2 08Q1 07Q4 11Q2 11Q3 10Q3 12Q1 11Q1 10Q4 13Q1 12Q4 12Q2 09Q3 09Q1 11Q4 09Q Unemployment rate Unemployment rate Panel C. Core CPI inflation Panel D. Core PCE inflation π t Eπ t BACK CPI CORE inflation Q4 08Q1 08Q2 07Q4 08Q2 08Q1 08Q3 08Q3 08Q4 11Q1 11Q2 11Q3 09Q2 09Q4 13Q1 12Q2 12Q1 11Q4 10Q3 12Q4 09Q1 10Q4 12Q3 09Q3 10Q2 10Q Unemployment rate Panel E. SPF inflation (CPI) forecasts Source: Coibion and Gorodnichenko (2015) t Eπ SPF t 11Q1 11Q2 09Q3 10Q4 09Q4 11Q3 12Q1 09Q2 12Q4 12Q3 10Q3 13Q1 11Q4 12Q2 10Q1 BACK Q4 08Q1 08Q2 07Q4 08Q1 08Q2 08Q3 08Q3 11Q2 09Q4 12Q1 11Q3 11Q109Q2 09Q3 13Q1 12Q412Q2 10Q2 10Q1 12Q3 11Q4 10Q3 10Q4 09Q Unemployment rate Panel F. Controlling for oil prices Eπ t BACK Nakamura-Steinsson (Columbia) Phillips Curve January / 55 π t Eπ t il price changes PCE CORE inflation 12Q4 12Q3 13Q1 12Q2 12Q1 09Q1 11Q1 11Q3 11Q2 09Q4 09Q3 10Q4 09Q2 10Q3 10Q1

40 π t Eπ t BA CPI CORE in Q4 08Q1 08Q2 MISSING 4DISINFLATION Q4 08Q2 08Q1 08Q3 08Q3 08Q4 11Q1 11Q2 11Q3 09Q2 09Q4 13Q1 12Q2 12Q1 11Q4 10Q3 12Q4 09Q1 10Q4 12Q3 09Q3 10Q2 10Q Unemployment rate Panel E. SPF inflation (CPI) forecasts π t Eπ t SPF 09Q3 10Q4 09Q4 11Q3 12Q1 09Q2 12Q4 12Q3 10Q3 13Q1 11Q4 12Q2 10Q1 09Q1 11Q1 11Q2 10Q Unemployment rate BAC PCE CORE in π t Eπ t BACK partial out oil price changes π t Eπ t Q4 08Q1 08Q1 08Q2 08Q2 08Q3 08Q3 12Q1 11Q109Q2 09Q3 13Q1 12Q412Q2 10Q2 10Q1 12Q3 11Q4 10Q3 10Q4 09Q Unemployment rate Panel F. Controlling for oil prices Figure 2. Robustness of the Missing Disinflation 12Q4 12Q3 13Q1 12Q2 12Q1 09Q1 11Q1 11Q3 11Q4 11Q Q4 09Q3 09Q2 10Q3 10Q1 10Q2 Unemployment rate, partial out oil price changes Source: Coibion and Gorodnichenko (2015) SPF forecast over next four quarters. Note: See notes for Figure 1 and the text for more details. 10Q4 movements during this period pushed inflation up despite the weak economy. The price of West Texas Intermediate (WTI) crude, for example, went from under 40 dollars per barrel in early 2009 to over 100 dollars per barrel in early 2011, Nakamura-Steinsson (Columbia) Phillips Curve January / 55

41 POSSIBLE EXPLANATIONS Does unemployment mismeasure forcing variable? Has the slope of the Phillips curve declined? Are inflation expectations by firms mismeasured? Nakamura-Steinsson (Columbia) Phillips Curve January / 55

42 ACCOUNTING FOR NATURAL RATE More natural to think of u t u n t as forcing variable Perhaps the natural rate of unemployment changed during Great Recession Nakamura-Steinsson (Columbia) Phillips Curve January / 55

43 ACCOUNTING FOR NATURAL RATE More natural to think of u t u n t as forcing variable Perhaps the natural rate of unemployment changed during Great Recession Two approaches: Use CBO estimates of natural rate of unemployment Ask what natural rate consistent with observed inflation dynamics? Nakamura-Steinsson (Columbia) Phillips Curve January / 55

44 ACCOUNTING FOR NATURAL RATE Reestimating Phillips curve with unemployment gap has no effect on slope CBO estimate of natural rate only rose by 1 percentage point in Great Recession Minimal effect on missing disinflation Nakamura-Steinsson (Columbia) Phillips Curve January / 55

45 ACCOUNTING FOR NATURAL RATE VOL.7 NO.1 COIBION AND GORODNICHENKO: THE MISSING DISINFLATION 207 Panel A. Missing disinflation with CBO unemployment gaps 4 09Q4 09Q3 π t Eπ t BACK Q4 08Q1 08Q2 08Q3 12Q4 12Q3 13Q1 12Q1 12Q2 11Q4 11Q1 11Q2 11Q3 09Q2 10Q4 10Q3 10Q1 10Q2 4 09Q Unemployment gap Source: Coibion and Gorodnichenko (2015) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

46 ACCOUNTING FOR NATURAL RATE Unemployment gap Panel B. Changes in natural rate of unemployment needed to explain missing disinflation Predicted natural rate Actual CBO natural rate 95% CI for predicted rate Actual unemployment rate Figure 3. Does the Missing Disinflation Reflect Structural Unemployment? Source: Coibion and Gorodnichenko (2015) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

47 HAS THE PHILLIPS CURVE FLATTENED? 212 AMERICAN ECONOMIC JOURNAL: MACROECONOMICS JANUARY 2015 Panel A. Sample split in mid-1980 s, backward-looking PC 4 09Q4 09Q3 2 07Q4 08Q3 11Q1 11Q2 09Q2 10Q4 π t Eπ t Back Q2 08Q1 12Q4 12Q3 13Q1 11Q3 12Q1 12Q2 11Q4 10Q3 10Q1 10Q Q Q Q Q Q Q1 09Q Unemployment gap Source: Coibion and Gorodnichenko (2015) Panel B. Sample split in mid-1980 s, forward-looking PC Nakamura-Steinsson (Columbia) Phillips Curve January / 55

48 HAS THE PHILLIPS CURVE FLATTENED? Unemployment gap Panel B. Sample split in mid-1980 s, forward-looking PC Q Q Q Q Q Q1 π t Eπ t SPF, GDP deflator Q1 08Q2 07Q4 08Q3 12Q3 12Q1 12Q2 13Q1 12Q4 11Q3 11Q2 11Q1 10Q3 10Q4 10Q2 10Q1 09Q1 09Q4 09Q3 2 11Q4 09Q Unemployment gap Source: Coibion and Gorodnichenko (2015) Figure 5. Time Variation in the Slope of the Phillips Curve Nakamura-Steinsson (Columbia) Phillips Curve January / 55

49 HAS THE PHILLIPS CURVE FLATTENED? Phillips curve appears to have flattened after 1985 Although statistical significance is weak (little variation in inflation after 1985) Can this account for missing disinflation? Nakamura-Steinsson (Columbia) Phillips Curve January / 55

50 CAN THIS ACCOUNT FOR MISSING DISINFLATION?.7 NO.1 COIBION AND GORODNICHENKO: THE MISSING DISINFLATION 213 Panel C. Counterfactual inflation paths from time-varying slopes Inflation (CPI) BACK PC, SPF PC, Actual BACK PC, SPF PC, Source: Coibion and Gorodnichenko (2015) Figure 5. (Continued) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

51 INFLATION EXPECTATIONS Perhaps inflation expectations of firms differ from backward-looking expectations and SPF forecasts Household expectations (Michigan survey) quite different Nakamura-Steinsson (Columbia) Phillips Curve January / 55

52 INFLATION EXPECTATIONS 218 AMERICAN ECONOMIC JOURNAL: MACRO Panel A. Inflation expectations for different economic agent Panel B. P inflation e Asset prices Michigan SPF (CPI) π t Eπ t MSC Source: Coibion and Gorodnichenko (2015) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

53 INFLATION EXPECTATIONS Not clear whether firm expectations behave like SPF or like household expectations But if they do behave like household expectations, does it matter? Nakamura-Steinsson (Columbia) Phillips Curve January / 55

54 INFLATION EXPECTATIONS CONOMIC JOURNAL: MACROECONOMICS JANUARY 2015 Asset prices Michigan SPF (CPI) π t Eπ t MSC Panel B. Phillips Curve with household inflation expectations Q4 08Q3 08Q1 09Q3 11Q1 09Q4 11Q2 10Q4 08Q2 11Q3 09Q2 12Q4 12Q3 12Q1 10Q3 12Q2 11Q4 13Q1 10Q1 4 10Q2 09Q Unemployment gap Source: Coibion and Gorodnichenko (2015) Panel D. Relative contribution of slopes 1960Q1 1984Q4 1985Q1 2007Q3 2007Q3 2013Q1 Nakamura-Steinsson (Columbia) Phillips Curve January / 55

55 INFLATION EXPECTATIONS Three differences versus SPF: No evidence of flattening Flatter throughout No evidence of missing disinflation! Nakamura-Steinsson (Columbia) Phillips Curve January / 55

56 0 INFLATION EXPECTATIONS Panel C. Counterfactual inflation (CPI) paths for different expectations Inflation Actual Backward PC SPF PC MSC PC Inflation Panel D and infl Figure 6. The Phillips Curve and the Missing Disinflation w Source: Coibion and Gorodnichenko (2015) Nakamura-Steinsson (Columbia) Phillips Curve January / 55

57 IMPORTANCE OF VOLCKER DISINFLATION Much of evidence for slope on Phillips curve comes from Volcker Disinflation Details turn out to matter for results Important methodological change in CPI in 1983 (housing switched to rental equivalence) 12-month inflation versus quarterly inflation matters No missing disinflation with 12-month PCE Nakamura-Steinsson (Columbia) Phillips Curve January / 55

MISSING DISINFLATION? + Slope Coefficients ( ) from Different Specifications Pre 2008 Post 2008 Missing Disinflation? 4 quarter PCE inflation, SPF exp. 0.09 (0.05) 0.06 (0.

58 MISSING DISINFLATION? + Slope Coefficients ( ) from Different Specifications Pre 2008 Post 2008 Missing Disinflation? 4 quarter PCE inflation, SPF exp (0.05) 0.06 (0.06) No 4 quarter core PCE, SPF exp (0.03) 0.08 (0.05) No Quarterly PCE, SPF exp (0.07) 0.02 (0.12) Yes Quarterly PCE, 4 quarter lagged exp (0.05) 0.10 (0.16) Yes Source: Nakamura (2018): Discussion at AEA Meetings Nakamura-Steinsson (Columbia) Phillips Curve January / 55

59 MISSING DISINFLATION? Source: Nakamura (2018): Discussion at AEA Meetings Nakamura-Steinsson (Columbia) Phillips Curve January / 55

60 DID E t π t+1 DO ALL THE WORK? Source: Nakamura (2018): Discussion at AEA Meetings Nakamura-Steinsson (Columbia) Phillips Curve January / 55

61 DID E t π t+1 DO ALL THE WORK? Source: Nakamura (2018): Discussion at AEA Meetings Quarterly PCE rather than 12-month Nakamura-Steinsson (Columbia) Phillips Curve January / 55

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