Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations

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RWP 20-11, September 2020; updated November 2021

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 the Federal Reserve's communication of a numerical inflation objective in 2012 better anchored inflation expectations. Moreover, this improved anchoring can account for much of the observed flattening of the Phillips curve in the US over the past decade. Similar analysis reveals no evidence of anchoring in Japan despite the Bank of Japan's announcement of a numerical target, suggesting that merely announcing an inflation objective may not be sufficient to better anchor inflation expectations.

JEL Classification: E31, E52, E58

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