The Flattening of the Phillips Curve: Policy Implications Depend on the Cause finds Cleveland Fed researcher

Many observers have been surprised that inflation hasn’t risen more than it has in the past few years as the economy has continued to strengthen. That’s because, according to the historical relationship known as the Phillips curve, strengthening of the economy is commonly associated with increasing inflation. In this commentary, Cleveland Fed researcher Filippo Occhino investigates what may be behind the flattening of the Phillips curve and the policy implications. Occhino shows that the flattening of the Phillips curve can be caused by two different types of changes, one a change in the structure of the economy unrelated to policy and the other a change in the behavior of monetary policy itself.

“When considering whether a change in the conduct of policy is appropriate following a flattening of the Phillips curve, simply knowing that the Phillips curve has flattened is not sufficient, there needs to be a focus on the possible causes,” Occhino says. “I show that the flattening can be due to very different types of structural changes and that knowing the type of change that has occurred is crucial for choosing the appropriate monetary policy.”

Occhino finds that the adoption of a new monetary policy rule, unresponsive to output and slightly more aggressive toward inflation, can have opposite effects on household welfare, depending on the cause of the flattening. The general point is that the flattening of the Phillips curve can be due to very different types of structural changes and the type of structural change is crucial for policy implications.

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Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell, doug.campbell@clev.frb.org, 513.218.1892