Dual Labor Market and the "Phillips Curve Puzzle"

TL;DR

This paper explores how changes in the dual labor market, such as bargaining power and workforce composition, have contributed to the flattening of the Phillips curve observed in recent years.

Contribution

It introduces a minimal model of the dual labor market to explain the causes behind the Phillips curve flattening, focusing on labor market structure changes.

Findings

Labor market changes plausibly explain the Phillips curve flattening.

Bargaining power and workforce composition significantly impact inflation dynamics.

Model aligns with recent low inflation despite low unemployment.

Abstract

Low inflation was once a welcome to both policy makers and the public. However, Japan's experience during the 1990's changed the consensus view on price of economists and central banks around the world. Facing deflation and zero interest bound at the same time, Bank of Japan had difficulty in conducting effective monetary policy. It made Japan's stagnation unusually prolonged. Too low inflation which annoys central banks today is translated into the "Phillips curve puzzle". In the US and Japan, in the course of recovery from the Great Recession after the 2008 global financial crisis, the unemployment rate had steadily declined to the level which was commonly regarded as lower than the natural rate or NAIRU. And yet, inflation stayed low. In this paper, we consider a minimal model of dual labor market to explore what kind of change in the economy makes the Phillips curve flat. The level of bargaining power of workers, the elasticity of the supply of labor to wage in the secondary market, and the composition of the workforce are the main factors in explaining the flattening of the Phillips curve. We argue that the changes we consider in the model, in fact, has plausibly made the Phillips curve flat in recent years.