Optimal inflation and the identification of the Phillips Curve

McLeay, Michael and Tenreyro, Silvana ORCID: 0000-0002-9816-7452 (2018) Optimal inflation and the identification of the Phillips Curve. CFM Discussion Paper Series (CFM-DP2018-15). Centre For Macroeconomics, London School of Economics and Political Science, London, UK.

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Abstract

This note explains why inflation follows a seemingly exogenous statistical process, unrelated to the output gap. In other words, it explains why it is difficult to empirically identify a Phillips curve. We show why this result need not imply that the Phillips curve does not hold – on the contrary, our conceptual framework is built under the assumption that the Phillips curve always holds. The reason is simple: if monetary policy is set with the goal of minimising welfare losses (measured as the sum of deviations of inflation from its target and output from its potential), subject to a Phillips curve, a central bank will seek to increase inflation when output is below potential. This targeting rule will impart a negative correlation between inflation and the output gap, blurring the identification of the (positively sloped) Phillips curve.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://www.centreformacroeconomics.ac.uk/Home.aspx
Additional Information:	© 2018 Centre for Macroeconomics
Divisions:	Centre for Macroeconomics
Subjects:	H Social Sciences > HB Economic Theory
Date Deposited:	05 Oct 2018 14:36
Last Modified:	01 Nov 2024 04:57
URI:	http://eprints.lse.ac.uk/id/eprint/90373

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