The Time‐Varying Phillips Correlation

Abstract

We use complex demodulation techniques to investigate changes in the correlation between real activity and inflation at the business-cycle frequencies in the United States, the United Kingdom, the Eurozone, and 10 other Organization for Economic Cooperation and Development (OECD) countries over the post-WWII era. Consistent with the analysis of Ball, Mankiw, and Romer (1988) we document a positive correlation between the time-varying average gain of real activity onto inflation at the business-cycle frequencies and inflation's Hodrick-Prescott trend, which is compatible with New Keynesian theories emphasizing the link between trend inflation, the frequency of price adjustments, and the slope of the Phillips trade-off. Copyright 2007 The Ohio State University.

Flattening of the Phillips curve under low trend inflation

“…Ball et al (1988) (hereafter BMR) suggest that the slope of the Phillips curve becomes flatter when the average rate of inflation is low. Recently, Benati (2007) has statistically verified BMR's argument using data from OECD countries.…”

Monetary Policy Strategy in a Global Environment

“…In a recent paper Benati (2007) provides another possible explanation to the flattening of the Phillips curve, which is rooted into the main thrust of the New Keynesian framework. In the standard firms" pricing rule assumed in those models, higher (lower) trend inflation increases (decreases) the frequency of firms" price adjustments -which is a "deep" parameter entering the reduced form coefficient of the output gap in the Phillips curve -thus increasing (reducing) the sensitivity of domestic inflation to cyclical fluctuations of output.…”

“…In the standard firms" pricing rule assumed in those models, higher (lower) trend inflation increases (decreases) the frequency of firms" price adjustments -which is a "deep" parameter entering the reduced form coefficient of the output gap in the Phillips curve -thus increasing (reducing) the sensitivity of domestic inflation to cyclical fluctuations of output. Benati (2007) shows that historically and across a large set of countries including the euro area, the time-varying slope of the Phillips curve is positively correlated to the trend rate of inflation. Hence, according to his interpretation, the decline in the coefficients of estimated reduced form…”

Monetary policy strategy in a global environment

“…In the standard fi rm pricing rule assumed in such models, higher (lower) trend infl ation increases (decreases) the frequency of fi rms' price adjustments -this being a "deep" parameter in the reduced-form coeffi cient of the output gap in the Phillips curve -thus increasing (reducing) the sensitivity of domestic infl ation to cyclical output fl uctuations. Benati (2007) shows that historically, and across a large set of countries including the euro area, the time-varying slope of the Phillips curve is positively correlated to the trend rate of infl ation. Hence, according to his interpretation, the decline in the coeffi cients of the estimated reduced-form Phillips curve for many OECD countries, including the euro area over the last two-three decades, is due to the progressive confi rmation of a low-infl ation environment.…”

“…In a recent paper Benati (2007) provides another possible explanation for the fl attening of the Phillips curve, which is rooted in the main thrust of the New Keynesian framework. In the standard fi rm pricing rule assumed in such models, higher (lower) trend infl ation increases (decreases) the frequency of fi rms' price adjustments -this being a "deep" parameter in the reduced-form coeffi cient of the output gap in the Phillips curve -thus increasing (reducing) the sensitivity of domestic infl ation to cyclical output fl uctuations.…”