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The Long-Run Phillips Curve is ... a Curve

Working paper 789
Working Papers
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Published: 17 August 2023

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In U.S. data, inflation and output are negatively related in the long run. A Bayesian VAR with stochastic trends generalized to be piecewise linear provides robust reduced-form evidence in favor of a threshold level of trend inflation of around 4%, below which potential output is independent of trend inflation, and above which, instead, potential output is negatively affected by trend inflation. Moreover, this negative relationship is quite substantial: above the threshold every percentage point increase in trend inflation is related to about 1% decrease in potential output per year. A New Keynesian model generalized to admit time-varying trend inflation and estimated via particle filtering provides theoretical foundations to this reduced-form evidence. The structural long-run Phillips Curve implied by the estimated New Keynesian model is not statistically different from the one implied by the reduced-form piecewise linear BVAR model.

Keywords: Long-Run Phillips Curve; Inflation; Bayesian VAR; DSGE; Particle Filter
JEL codes C32; C51; E30; E31; E52

Working paper no. 789

789 - The Long-Run Phillips Curve is ... a Curve

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Research highlights:

  • We empirically question one of the foundations of modern Macroeconomics: the absence of a long-run relation between output and inflation.
  • We find that in U.S. data, inflation and output are negatively correlated in the long run and their relation is non linear.
  • Above a threshold of about 4%, every percentage point increase in trend inflation is related to about 1% decrease in potential output.
  • The estimated potential output loss during the Great Inflation period has been, on average, about negative 2% per year.
  • An estimated Generalized New Keynesian model, which allows for time varying trend inflation, corroborates these findings.

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