Has the Phillips Curve Become Steeper?

HasthePhillipsCurveBecomeSteeper? AnilAri,DanielGarcia-MaciaandShrutiMishra WP/23/100 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 MAY ©2023InternationalMonetaryFundWP/23/100 IMFWorkingPaper EuropeanDepartment HasthePhillipsCurveBecomeSteeper? PreparedbyAnilAri,DanielGarcia-MaciaandShrutiMishra* AuthorizedfordistributionbyS.AliAbbasMay2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:ThispaperanalyzeswhetherstructuralchangesintheaftermathofthepandemichavesteepenedthePhillipscurvesinadvancedeconomies,reversingtheflatteningobservedinrecentdecadesandreducingthesacrificeratioassociatedwithdisinflation.Particularly,analysisofgranularpricequotedatafromtheUKindicatesthatincreaseddigitalizationmayhaveraisedpriceflexibility,whilede-globalizationmayhavemadeinflationmoreresponsivetodomesticeconomicconditionsagain.Usingsectoraldatafrom24advancedeconomiesinEurope,higherdigitalizationandlowertradeintensityareshowntobeassociatedwithsteeperPhillipscurves.Post-pandemicPhillipscurveestimatesindicatesomesteepeningintheUK,Spain,Italyandtheeuroareaasawhole,butatmagnitudesthataretoosmalltoexplaintheentiresurgeininflationin2021–22,suggestinganimportantroleforoutwardshiftsinthePhillipscurve. RECOMMENDEDCITATION:Ari,A.,Garcia-Macia,D.,andMishra,S.(2023).HasthePhillipsCurveBecomeSteeper?IMFWorkingPaper,WP/23/100 JELClassificationNumbers:E31,E52,O33,F41Keywords:PhillipsCurve;Inflation;De-globalization;Digitalization;StructuralchangeAuthor’sE-MailAddress:aari@imf.org,dgarciamacia@imf.org,sm4371@columbia.edu *ThispaperbenefitedfromtheguidanceofS.AliAbbas,MarkFlanaganandLauraPapi,andhelpfulcommentsfromTommasoAquilante,HelgeBerger,OyaCelasun,RuoChen,RomainDuval,ChristianGlocker,MyrtoOikonomou,SaskiaterEllen,BoromeusWanengkirtyo,andseminarparticipantsattheBankofEnglandandHisMajesty'sTreasury.WearegratefultoGloriaLiforexcellentresearchassistance. WORKINGPAPERS HasthePhillipsCurveBecomeSteeper? PreparedbyAnilAri,DanielGarcia-MaciaandShrutiMishra1 1ThispaperbenefitedfromtheguidanceofAliAbbasandMarkFlanagan,andhelpfulcommentsfromTommasoAquilante,RuoChen,RomainDuval,ChristianGlocker,MyrtoOikonomou,SaskiaterEllen,BoromeusWanengkirtyo,andothercounterpartsattheBankofEnglandandHisMajesty'sTreasury. Contents 1.INTRODUCTION3 2.RELATEDLITERATURE5 3.EMPIRICALFRAMEWORKANDDATA7 3.1SectoralPhillipsCurveEstimation7 3.2DigitalizationandPriceFlexibility8 3.3DataSourcesandConstruction8 4.EMPIRICALRESULTSANDROBUSTNESS10 4.1SectoralPhillipsCurveRegressions10 4.2DigitalizationandPriceFlexibility14 5.POST-PANDEMICPHILLIPSCURVEESTIMATION15 6.CONCLUSION16 FIGURE 1.PhillipsCurveSlope4 TABLES 1.CountriesandSectorsIncludedinthePanelDataset9 2.BaselineEmpiricalResults12 3.RobustnessCheck13 4.DigitalizationandPriceFlexibilityResults14 References17 1.Introduction ThePhillipscurve,definedastheempiricalrelationshipbetweenunemploymentandinflation,illustratesthetrade-offbetweenmaintainingpricestabilityandachievingfullcapacityutilization.TherecenthistoryofthePhillipscurvehasbeenapuzzle.ManystudieshaveconcludedthatthePhillipscurvehasflattenedinadvancedeconomiesinrecentdecades(seee.g.,Blanchard,2016;DelNegroandothers,2020amongmanyothers),whileothershavedocumentedthemutedreactionofinflationtolargechangesinunemploymentduringandaftertheGreatRecession(CoibionandGorodnichenko,2015;Heiseandothers,2022). Theliteraturehasproposedanumberofexplanationsforthisphenomenon.First,theimplementationofinflationtargetingmayhaveincreasedthecapacityofmonetarypolicytoneutralizedemandshocks(whichwouldmoveinflationandunemploymentinoppositedirections),leavingsupplyshocks(whichmovetheminthesamedirection,shiftingthePhillipscurveinwards/outwards)asthemainsourceofaggregatevolatility(Broadbent,2020;Bergholt,andothers,2023).Second,firmeranchoringofinflationexpectationsmayhavereducedsecond-roundeffectsofrelativepriceshocks(Borioandothers,2021).Third,globalizationmayhavereducedtheresponsivenessofinflationtodomesticeconomicslackandunemployment(Heiseandothers,2022),includingbyraisinglabormarketflexibilitythroughareductioninlaborbargainingpower(Lombardiandothers,2020).Fourth,increasedmarketpowermayhaveaugmentedfirms’capacitytoabsorbcost-pushshocksintheirmarkups(Baqaee,FarhiandSangani,2021). Someofthesestructuraltrendsmayhavestartedtoreverseinrecentyears.Therecentriseininflationtohistoricallyhighlevelsinadvancedeconomiesrisksweakeningtheanchoringofinflationexpectationsachievedoverthepasttwodecades.Ade-globalizationscenariomayalsomakethedomesticoutputgapmorerelevantagain,aswellasrestoringsomelaborbargainingpower(GoodhartandPradhan,2020).NewstructuralfactorsmayhavealsocontributedtoasteepeningofthePhilli