Working Paper: NBER ID: w25987
Authors: James H. Stock; Mark W. Watson
Abstract: We investigate the flattening Phillips relation by making two departures from standard specifications. First, we measure slack using real activity variables that are bandpass filtered or year-over-year changes in activity (these are similar), instead of gaps. Second, we study the components of inflation instead of the standard aggregates. We find that some inflation components have strong and stable correlations with the cyclical component of real activity; these components tend to be relatively well-measured and domestically determined. Other components, typically prices that are poorly measured or internationally determined, have weak and/or unstable correlations with cyclical activity. We construct a new inflation index, Cyclically Sensitive Inflation, that weights the components by their joint cyclical covariation with real activity. The index has strong and stable correlations with cyclical activity and provides a real-time measure of cyclical movements in inflation.
Keywords: Inflation; Phillips Curve; Cyclical Activity; Monetary Policy
JEL Codes: E31; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cyclically sensitive inflation (CSI) index (E31) | cyclical real activity (E32) |
| well-measured inflation components (E31) | cyclical activity (E32) |
| poorly measured inflation components (E31) | cyclical activity (E32) |
| inflation components (housing and food services) (R31) | cyclical correlations (E32) |
| poorly measured inflation components (E31) | weaker associations with cyclical activity (E32) |