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The Phillips Curve equation is: $$\pi_t=\pi_t^e + \beta_1 (\beta_2 Y_t + (1-\beta_2) Z_t) + \varepsilon_t^\pi$$ where $\pi_t$ is the inflation, $\pi_t^e$ is the expected inflation, $Y_t$ is the output level, $Z_t$ is the real exchange rate, and $\varepsilon_t^\pi$ is a stochastic shock.

In a small open economy (semi-structural framework), the impulse response functions to a domestic demand shock are the following:

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After the crisis, the Phillips Curve became flatter. My question is, how can one interpret the change in the slope of the Phillips Curve after the crisis?

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(1) The Phillips curve is not a structural thing, it is not surprising that the relationship between unemployment and inflation is not constant over time.

(2) There's a nice AER paper by Simon Gilchrist and coauthors that argues that inflation did not go down as much as in earlier recessions because financially constrained firms needed to keep their cash-flows up and increased prices.

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After the Financial crisis of 2007–2008, the inflation's decay became more persistent in many countries. There are several reasons why:

  • The output gap went below zero in developed economies, however, the inflation level decayed moderately only.
  • Changes in the structure of employment. The relative rate of highly educated had increased, therefore, the average level of wages raised as well.
  • Fiscal consolidation. The rise of indirect taxation could hold the inflation at extraordinary high level, too.
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