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Federal Reserve Bank of Cleveland
Working Papers
Variation in the Phillips Curve Relation across Three Phases of the Business Cycle
Richard Ashley
Randal Verbrugge

We use recently developed econometric tools to demonstrate that the Phillips curve unemployment rate–inflation rate relationship varies in an economically meaningful way across three phases of the business cycle. The first (“bust phase”) relationship is the one highlighted by Stock and Watson (2010): A sharp reduction in inflation occurs as the unemployment rate is rising rapidly. The second (“recovery phase”) relationship occurs as the unemployment rate subsequently begins to fall; during this phase, inflation is unrelated to any conventional unemployment gap. The final (“overheating phase”) relationship begins once the unemployment rate drops below its natural rate. We validate our findings in a forecasting exercise and find statistically significant episodic forecast improvement. Our analysis allows us to provide a unified explanation of many prominent findings in the literature.

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Richard Ashley & Randal Verbrugge, Variation in the Phillips Curve Relation across Three Phases of the Business Cycle, Federal Reserve Bank of Cleveland, Working Papers 190900, 03 May 2019.
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Keywords: overheating; recession gap; persistence dependence; NAIRU
DOI: 10.26509/frbc-wp-201909
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