The Role of Industrial Composition in Driving the Frequency of Price Change
This paper assesses the degree to which a shift in the industrial composition in the United States from manufacturing toward services has reduced the frequency of price change and thus flattened the slope of the Phillips curve and affected the associated inflation dynamics.
One of the most crucial parameters in monetary economics is the frequency of price change. If the frequency of price change is low, then nominal shocks have real effects—because prices cannot adjust quickly enough, restoring equilibrium in the economy requires real changes. Thus, with a lower frequency of price change, the economy demonstrates greater monetary non-neutrality. This also implies that when the frequency of price change is low, achieving a given reduction in inflation requires a larger increase in unemployment.
In this way, the frequency of price change is a key determinant of the slope of the Phillips curve, which depicts the inverse relationship between inflation and the unemployment rate. The negative relationship was most clearly observed in the post–World War II period. However, in recent decades and particularly following the Great Recession and before the onset of the COVID-19 pandemic, the Phillips Curve was difficult to detect. The flattening of the Phillips curve in the United States could be explained by a reduction in the frequency of price change, which in turn could be explained by the shift in the economy's industrial composition.
The flattening of the Phillips curve has coincided with a shift in the focus of the US economy from primary and secondary industries (industries that extract raw materials and those that process them, respectively) toward tertiary industries (industries that provide services). Because products in the tertiary industries have lower frequencies of price change compared with products in the primary and secondary industries, it is reasonable to expect that as the tertiary-industry share of the economy increases over time, there would be a concurrent downward shift in the distribution of the frequency of price change and that this shift would flatten the Phillips curve.