Non-Linear Phillips Curves with Inflation Regime-Switching

Abstract

Building on the results in Nalewaik (FEDS 2015-93), this work models wage growth and core PCE price inflation as regime-switching processes, whose characteristics in the 1970s, 1980s and early 1990s differ fundamentally from their characteristics in the 1960s and from the mid-1990s to present. The key innovation here is the addition to the models of fundamental driving variables like labor-market slack, and the evidence strongly suggests a non-linear effect of slack on wage growth and core PCE price inflation that becomes much larger after labor markets tighten beyond a certain point. The results are informative for assessing the likelihood and risks of meeting certain inflation targets on a sustained basis.

Keywords: Markov-switching, NAIRU, threshold regressions, Wage Inflation, Core PCE prices

JEL Classification: E31, E37, E51, E58, C22