Should the Fed Base Policy Decisions on a Linear Phillips Curve?

Doug Laxton, Dave Rose and Demos Tambakis - International Monetary Fund

Recent statistical rejections of convexity in the Phillips curve have been uninformative because researchers have employed measures of business cycle gaps that are fundamentally inconsistent with the key implications of convexity. This paper studies a preferred statistical methodology that places both the linear and nonlinear models on an equal statistical footing by constructing model consistent measures of the business cycle. The paper also shows that if policymakers are successful in avoiding large boom and bust cycles it may become even more difficult to identify convexity in the Phillips. To the extent that convexity in the Phillips curve is used as a rationale for stabilization

Scheduled for Session 1.3 Optimum Policy Making Under Uncertainity