Why has the Phillips curve flattened in recent decades?

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AcadiFi · Accepted Answer

The Phillips curve posits an inverse relationship between unemployment and inflation: tight labor markets push wages and prices higher. Since 2000, this relationship has flattened—inflation barely responded to unemployment falling from 10% in 2009 to 3.5% in 2019. Explanations include:

(1) Anchored inflation expectations: Central bank credibility since Volcker has anchored long-run inflation expectations near 2%, breaking the wage-price spiral that amplified 1970s inflation. Firms no longer expect persistent inflation, so they don't raise prices aggressively even when wages tick up.

(2) Globalization and supply chains: Foreign competition caps domestic price increases; manufacturers relocate when US labor gets tight. Import price pass-through has become a dominant driver of CPI.

(3) Labor market changes: Declining unionization, rise of gig/contract work, and labor-replacing technology weaken wage bargaining power. Firms respond to tight markets by automating rather than raising wages.

(4) Measurement issues: Hedonic adjustments, owners' equivalent rent, and digital services complicate inflation measurement. True inflation may differ from headline CPI.

(5) Slack mis-measurement: U-3 unemployment may understate slack; U-6 or prime-age employment-population ratio shows more room for expansion without wage pressure.

The 2021-2023 reflation disrupted the flattening narrative—when supply shocks hit and expectations began de-anchoring, the Phillips curve steepened sharply. Greystone should monitor expectation surveys (Michigan, NY Fed) and wage growth decompositions rather than relying on a static Phillips curve for policy rate forecasting.

Why has the Phillips curve flattened in recent decades?

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