Abstract
A sharp increase in unemployment accompanied by a relatively muted response of inflation during the Great Recession added further doubts to the validity of the Phillips curve and the existence of a systemic relationship between economic activity and inflation. This paper aims to show to what extent the uncertainty about the choice of proper forcing variable contributes to the ambiguity of the evidence on the Phillips curve in the United States and other G7 countries.
We use dynamic model averaging (Raftery et al., 2010), which marries the flexibility of the time-varying parameter framework with the possibility of model switching in each period. Our results show that inflation seems to respond to different measures of economic activity across time and space to a varying extent and no measure of economic activity clearly dominates in all countries or over the whole sample.
The output gap is often outperformed by unemployment-related variables such as the short-term unemployment rate, the unemployment expansion gap, and the unemployment recession gap. Finally, we find a weakening of the inflation-activity relationship (i.e., a flattening of the Phillips curve) in the last decade that is robust both across activity measures and across countries.