Phillips curve estimation during tranquil and recessionary periods: evidence from panel analysis

TL;DR

This paper analyzes the Phillips Curve during different economic periods across 41 countries from 1980 to 2016, revealing that the relationship weakens or disappears during recessions but remains valid during tranquil times.

Contribution

It provides empirical evidence on the changing dynamics of the Phillips Curve during recessionary versus tranquil periods using panel analysis across multiple countries.

Findings

Phillips Curve relationship invalid during recessions

Relationship remains valid during tranquil periods

Both inflation expectations gain importance in recessions

Abstract

The empirical literature that covers Phillips Curve analysis during recessionary periods is notably scant. The Great Recession has rekindled a debate on the validity and stability of the Phillips Curve which is still ongoing. The basis for this debate is the observation that real activity dropped sharply without causing a drop in inflation. This paper carries out an empirical analysis for the classical expectation-augmented Phillips curve model across 41 countries from1980-2016 by distinguishing tranquil and recessionary periods separately. Based on the results of the research, the paper finds that dynamics of Phillips Curve changes during recessionary periods and the empirical relationship becomes no longer valid. These findings support the ongoing debate about the missing disinflation and collapse of the Phillips curve, but only during the recessionary periods. In the case of tranquil periods, the empirical relationship still seems to be valid. Moreover, the paper also observes that both backward-looking and forward-looking fractions of inflation gain weight and significance during recessionary periods. However, the paper remains indecisive about which exact fraction gains more weight and significance as the panel model does not incorporate these two fractions of inflation in a single hybrid framework simultaneously.