PDFDownload paper, RWP 20-11, September 2020

In a macroeconomic model with drifting long-run inflation expectations, the anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better-anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the United States but failed to anchor expectations in Japan. Moreover, the improved anchoring of U.S. inflation expectations can account for much of the observed flattening of the Phillips curve. Finally, we present evidence that initial Federal Reserve communication around its longer-run inflation objective may have led inflation expectations to anchor at a level below 2 percent.

JEL Classification: E31, E52, E58

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Article Citation

  • Bundick, Brent, and A. Lee Smith. “Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations.” Federal Reserve Bank of Kansas City, Research Working Paper no. 20-11, September. Available at External Linkhttps://doi.org/10.18651/RWP2020-11

Authors

Brent Bundick

Sr. Research and Policy Advisor

Brent Bundick is a Senior Research and Policy Advisor in the Economic Research Department of the Federal Reserve Bank of Kansas City. He rejoined the Department in 2014 after com…

A. Lee Smith

Vice President and Economist

Andrew Lee Smith is a Vice President and Economist in the Economic Research Department of the Federal Reserve Bank of Kansas City. Prior to joining the department in 2014, Mr. Sm…