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BPEA Article

The Evolution of Inflation Dynamics and the Great Recession

Laurence Ball and Sandeep Mazumder


This paper examines inflation dynamics in the United States
since 1960, with a particular focus on the Great Recession. A puzzle emerges
when Phillips curves estimated over 1960–2007 are used to predict inflation
over 2008–10: inflation should have fallen by more than it did. We resolve this
puzzle with two modifications of the Phillips curve, both suggested by theories of
costly price adjustment: we measure core inflation with the weighted median
of consumer price inflation rates across industries, and we allow the slope
of the Phillips curve to change with the level and variance of inflation. We
then examine the hypothesis of anchored inflation expectations. We find that
expectations have been fully “shock-anchored” since the 1980s, while “level
anchoring” has been gradual and partial, but significant. It is not clear whether
expectations are sufficiently anchored to prevent deflation over the next few
years. Finally, we show that the Great Recession provides fresh evidence against
the New Keynesian Phillips curve with rational expectations.