Inflation/unemployment regimes and the instability of the Phillips curve

Abstract

Using the statistical technique of fuzzy clustering, regimes of inflation and unemployment are explored for the United States, the United Kingdom and Germany between 1871 and 2009. We identify for each country three distinct regimes in inflation/unemployment space. Similarities exist across countries in both the regimes and the timings of the transitions between regimes. However, the typical rates of inflation and unemployment experienced in the regimes are substantially different. Further, even within a given regime, the results from the cluster analysis reveal persistent fluctuations in the degree of attachment to that regime of inflation/unemployment observations over time. The economic implications of this are that, first, the inflation/unemployment relationship or Phillips curve experiences from time to time major shifts. Second, that it is also inherently unstable even in the short run. It is likely that the factors which govern the inflation/unemployment trade-off are so multi-dimensional that it is hard to identify periods of short-run Phillips curves which can be assigned to particular historical periods with any degree of accuracy or predictability. The analysis shows that reliance on a trade-off between inflation and unemployment for policy purposes is misplaced even in the short run.

Keywords:

• Phillips curve
• inflation
• structural change
• fuzzy clustering

JEL Classification::

• C19
• E31
• N10

Notes

¹ On this point, see Atkinson (1969) for a fascinating analysis. The study looks at the time dimension of different models of economic growth. It is argued herein that an understanding of the speed of change of key variables within the model is crucial in terms of evaluating the model's predictive power and that the long run could be very long indeed.

² For example, there is no consensus as to the variable or variables which should be used empirically to express the level of demand. Unemployment is frequently used, and was indeed chosen for the seminal article on the Phillips curve attempting to describe the relationship between inflation and the level of demand in pre-First World War Britain (Phillips, 1958). But even then, different researchers may estimate different functional forms for any particular empirical relationship.

³ An example of this is an oil price shock which pushes up inflation and the costs of production, which then leads to a fall in the level of employment.