Cleveland Fed, Report: The Intermittent Phillips Curve, Finding a Stable (But Persistence-Dependent) Phillips Curve Model Specification

“More broadly, we would like to emphasize the clear implications of the work presented here with regard to current and future monetary policy deliberations. As noted by John Cochrane (quoted in Steelman et al., 2013, p.36), “The prevailing theory of inflation these days has nothing to do with money or transactions: the Fed sets interest rates, interest rates affect “demand,” and then demand affects inflation through the Phillips curve.” Even prior to the current challenges presented by the COVID collapse and recovery, the recent experience – of year after year of zero nominal interest rates, anchored inflation expectations, and low inflation – suggests difficulty in fine-tuning inflation. Even with anchored inflation expectations, the movement of inflation toward its long-run expected level is evidently quite slow. What can monetary policy do to speed up this journey? If inflation is too low, it takes an appreciable amount of overheating before there is a significant upward force on inflation. If inflation is too high, it can be slowed rapidly – but only via a rapid upward movement in the unemployment rate, i.e., a recession.”