Inflation Expectations and Nonlinearities in the Phillips Curve

This paper examines the role of inflation expectations and nonlinearities in the Phillips curve. We find that nonlinearities per se can address the missing disinflation. The estimated model favors two regions, with a flatter slope of the Phillips curve when unemployment is already high. This can explain why during the Great Recession inflation did not decrease as much as predicted by linear models. We also find that consumer expectations can explain the missing disinflation and prove to be a more robust feature of the Phillips curve. Namely, consumer expectations are also key in addressing the Great Inflation in the 1970s and the Volcker disinflation in the 1980s, periods in which nonlinearities have difficulty fitting the data. Our results suggest that both nonlinearities and consumer expectations should be examined jointly and that the latter is a more prevalent feature of the Phillips curve.