Nicholas Bloom (Stanford): How curvy is the Phillips curve?
Abstract: Macro data suggest a convex relationship between inflation and economic slack, but identifying causality is challenging. Using micro data from large panel surveys of UK and US firms, we show that the response of prices to demand shocks is also convex at the firm level. We obtain similar results using three different empirical exercises examining: hypothetical shocks from a survey exercise, the response to sales shocks, and the impact of COVID demand shocks. This convexity is strongest in firms and industries with higher inflation, disappears at horizons beyond two years, and is also present in response to cost shocks. Taking non-linearities into account helps explain around one-fourth of the increase in firm price growth in 2022. We rationalize these findings in a menu cost model with positive trend inflation and decreasing returns at the firm level, which replicates firm and aggregate Phillips curve convexity. The non-linearity emerges from trend inflation pushing firms closer to their price increase thresholds.
Economics
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