February 13th, 2021

The Legend


The proposed Covid-19 stimulus package in the US has reignited debate around inflation. Much contemporary concern and discussion on the topic still bears the mark of the 1970s, the Volcker disinflation, and the past consensus around the relationship between unemployment and inflation.

In a recent paper, Jonathon Hazell, Juan Herreño, Emi Nakamura, and Jón Steinsson find evidence that points instead to the determining role of expectations around future monetary policy.

From the paper:

"The episode in US economic history that has perhaps most strongly influenced the profession’s thinking regarding the slope of the Phillips curve is the Volcker disinflation. In the early 1980s, Paul Volcker’s Federal Reserve sharply tightened monetary policy. Unemployment rose sharply and inflation fell sharply. The conventional interpretation of this episode is that it provides evidence for a relatively steep Phillips curve. The insensitivity of inflation to changes in unemployment over the past few decades has led many economists to suggest that the Phillips curve has disappeared—or is 'hibernating.' During the Great Recession, unemployment rose to levels comparable to those during the Volcker disinflation, yet inflation fell by much less. The 'missing disinflation' during and after the Great Recession then gave way to 'missing reinflation' in the late 2010s as unemployment fell to levels not seen in 50 years, but inflation inched up only slightly. A similar debate raged in the late 1990s, when unemployment was also very low without this leading to much of a rise in inflation. Some have argued that the apparent flattening of the Phillips curve signals an important flaw in the Keynesian model.

An alternative to the standard narrative of the Volcker disinflation is that the decline in inflation was driven not by a steep Phillips curve but by shifts in beliefs about the long-run monetary regime in the United States that caused the rapid fall in long-run inflation expectations. Volcker’s monetary policy constituted a sharp regime shift that was imperfectly credible at the outset but became gradually more credible as time passed. This regime shift led to a large and sustained decline in long-term inflation expectations over the 1980s but also a transitory rise in unemployment. Perhaps it was this large change in inflation expectations that was the primary cause of the rapid fall in inflation over this period rather than high unemployment working through a steep Phillips curve."

Link to the paper.

  • Employ America's Skanda Amarnath and Alex Williams blog on "Inflation: the good, the bad, the transitory." Link. And Tim Barker blogs on the present inflation discourse. Link.
  • "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." Laurence Ball and Sandeep Mazumder analyze inflation after the Great Recession. Link. And James Stock and Mark Watson probe the question of inflation forecasting. Link.
  • Two recent Phenomenal World essays on the topic: Yakov Feygin on "The Deflationary Coalition" and Andrew Elrod on "Inflation, Specific and General." Link, and link.
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