Charts of the Year: Rethinking the Phillips curve

As the FT has covered extensively this year, something strange is going on with the relationship between jobs and inflation. For his part, Frederik Ducrozet, senior European economist at Pictet Wealth Management thinks the Phillips curve still holds, but it requires new perspectives in the euro area.

In his submission for fastFT’s Charts of the Year, Mr Ducrozet says:

We agree with ECB’s Benoît Coeuré who said that the euro area Phillips curve wasn’t dead but “flatter, non-linear or mis-specified in terms of the relevant economic slack”.

Using the ECB’s measure of broad unemployment, a European version of the U6 rate, we find that the Phillips curve still holds although global factors continue to play an important role, in our view. But even so, the concept of a single, homogeneous, aggregate Phillips curve for the euro area has become less relevant after the crisis, with heterogenous hysteresis effects from one country to the other affecting the relationship between economic slack, wage growth and core inflation.

Using various model specifications, we find that the dispersion in the slopes of national Phillips curves has increased in recent years. The ECB remains confident that stronger growth and lower unemployment will ultimately push inflation higher, but one should be looking at the 19 national Phillips curves to be sure.