Sectoral Inflation and the Phillips Curve: What Has Changed since the Great Recession?
The aggregate Phillips curve, a pillar of inflation dynamics models, predicts that as the labor market tightens, prices eventually face an upward pressure, and inflation rises. Yet, while the unemployment rate decreased from a peak of 9.9 percent in the fourth quarter of 2009 to 4.3 percent in the third quarter of 2017, core inflation remained below the Federal Open Market Committee’s target of 2 percent.
This anomaly has led some economists to question the usefulness of the aggregate Phillips curve as a model for policy analysis. However, others continue to believe the Phillips curve remains informative, and that the recent changes in inflation dynamics can be reconciled with the models by allowing for a structural break in model parameters.
This policy brief looks at disaggregated inflation data to see whether a sectoral Phillips curve, which characterizes the relationship between sectoral inflation and aggregate unemployment, can explain changing inflation dynamics. Sectoral data provide rich variation in disaggregated inflation rates within and between sectors and allow us to identify the sectors that may have contributed the most to a possible break. With this approach, we also can more closely consider individual inflation series. For example, we can study inflation persistence at the sectoral level. Using disaggregated inflation data also enables us to investigate the role of transitory sectoral shocks, some of which, including price wars in the communications sector, have been the focus of recent inflation debates.