Mystery of Modern Phillips Curve

Abstract

The modern Phillips curve is about the relationship between inflation and unemployment and has been the center of a fierce debate in economics over fifty years. This paper reports empirical evidence that uncovers some of its mysteries. The rate of inflation and the unemployment rate are closely related to business cycles. What is of interest is that no two business cycles are exactly alike; however, all business cycles are essentially alike [1,2]. Each expansion is ended by a recession induced by adverse shocks. The U.S. economy suffers from adverse shocks all the time, but not every shock gives rise to a recession. Why do adverse shocks often induce a recession after an expansion that has lasted for a substantial duration? That is, why are double-dip recessions so rare? Here do we find important evidence in the Phillips curve that may help answer this question. We also discuss some issues related to the monetary policy and raise a few open questions about the relationship between unemployment and business cycles.