The Unemployment-Inflation Trade-off Revisited: The Phillips Curve in COVID Times

Abstract

We estimate the natural rate of unemployment, often referred to as u*, in the United States using data on labor market flows, short-term and long-term inflation expectations and a forwardlooking New-Keynesian Phillips curve for the 1960-2021 period. The natural rate of unemployment was at around 4.5% before the onset of the pandemic and increased to 5.9% by the end of 2021. This pronounced rise was primarily informed by strong wage growth rather than changes in inflation expectations. Despite the rise in the natural rate of unemployment, the secular trend of unemployment continued to fall and stands at around 4.2% reflecting ongoing secular developments which have been pushing down the unemployment rate over the last 30 years. Our model forecasts strong wage growth to moderate only sluggishly continuing to put upward pressure on inflation in the medium-run. We project underlying inflation to remain 0.5 percentage points above its long-run trend by the end of 2023 even if long-run inflation expectations remain well anchored.Given the importance of wage growth for the inflation outlook, we examine detailed micro data on job-filling rates, posted wages for vacant positions, and workers' reservation wages. In particular, we construct a composition-bias free measure of wage growth at the employer-job level using Burning Glass Technologies data and document strong wage growth for both teleworkable and non-teleworkable jobs. Moreover, we find that workers' reservation wages increased substantially after the pandemic. Our empirical analysis suggests that the strong wage growth is likely not a one-time adjustment of additional compensation for jobs that pose health risks to workers but rather reflects a tight labor market accompanied with a changing work-leisure trade-off.

Has the Willingness to Work Fallen during the Covid Pandemic?

“…These studies identify a reduction in job search effort, either directly or indirectly, as a contributor to labor market tightness across multiple countries. Our findings are consistent with recent work, such as Domash and Summers (2022) and Crump et al (2022), that argue that the U.S. labor market at the end of 2021 is tighter than in 2019 using alternative measures of labor market tightness. Our study is also related to research on a declining trend in the willingness to work that predates the pandemic (Barnichon and Figura, 2016).…”

Macro-Financial Stability in the COVID-19 Crisis: Some Reflections

“…However, even though most central banks have shifted gears, inflationary pressures remain unabated so far and short-to medium-term inflation expectations remain well above central banks' targets (Figure 11, panels a and b). Amid tight labor markets, wage growth has also picked up to above pre-pandemic levels raising concerns of a wage-price spiral (Crump et al 2022, Domash & Summers 2022. Central banks have thus come under increased public scrutiny for acting too late, thereby worsening the inflation-output tradeoff they face (Figure 11, panels c and d).…”

Prospects for Growth and Change: U.S. Metro Area Forecasts 2022–2032

“…This is significantly lower than the long-term average unemployment rate of around 5%. Crump et al (2022) estimated the natural rate of unemployment at 4.5% pre-COVID-19 pandemic, and 5.9% at the end of 2021. The Federal Reserve has indicated forward policy to balance the labor market, implying a significantly higher nonaccelerating inflation rate of unemployment.…”