The possible unemployment cost of average inflation below a credible target

Author / Creator

Svensson, Lars E. O

Available as

Online

Summary

If inflation expectations become firmly anchored at a fixed inflation target even if average inflation deviates from the target, the long-run Phillips curve is no longer vertical but becomes downwa...

If inflation expectations become firmly anchored at a fixed inflation target even if average inflation deviates from the target, the long-run Phillips curve is no longer vertical but becomes downward-sloping, and the tradeoff between average inflation and average unemployment reappears. This seems to have happened for Sweden and possibly for other countries with a credible inflation target. During the 15 years of 1997-2011, inflation expectations in Sweden have been anchored at the inflation target of 2 percent, but average CPI inflation has fallen 0.6 percentage points below the target. In contrast, in Australia, Canada, and the U.K. inflation has been on or very close to the target. The data indicate that the slope of the Swedish long-run Phillips curve is about 0.75. Then the average unemployment rate has been about 0.8 percentage points higher during 1997-2011 than if average inflation had been on target. This is a large unemployment cost of undershooting the inflation target. For Canada and the U.S., the long-run Phillips curve also seems downward-sloping, but since average inflation has equaled the explicit or implicit target, there is no unemployment cost of undershooting the target.

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