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The Expectational Phillips Curve Is Highly Nonlinear When Inflation Is Low

Subsiding Inflation  NYTimes com

Why this is the case is surprising--I thought that our inflation rate would be a lot closer to zero now than it is. Akerlof, Dickens, and Perry had interesting thoughts about why this might happen a decade or so ago…

Paul Krugman marks his beliefs to market:

Subsiding Inflation: [W]hile the inflationistas have been totally wrong, deflationistas like me haven’t been completely right. Here’s a chart, showing unemployment and core inflation during and after two big recessions; in each case the time series starts at the upper left.

I thought this slump would produce a “clockwise spiral” like the 80s recession…. That is, among other things, what textbook adaptive-expectations Phillips curves say should happen. So I thought we might well be into deflation by this point. Instead, while you can see a clockwise spiral, sort of, if you squint, it has been “scrunched” as if it’s bouncing off a hard surface at or near zero.

And that’s almost surely exactly what has happened. Downward nominal rigidity — the great difficulty of actually cutting wages and many prices — is now obvious. And research into PLOGs — prolonged large output gaps — shows that this is a general phenomenon.

So we’ve learned something about price dynamics at low inflation, and some predictions from people like me have proved somewhat wrong. That said, the world is looking a lot more like what the deflationista/liquidity trap types predicted than what the other side claimed would happen.

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