What Makes the Output–Inflation Trade-Off Change? The Absence of Accelerating Deflation in Japan


  • This paper is based on the first chapter of my thesis at the Johns Hopkins University. I thank the editor, Kenneth West, and three anonymous referees for their feedback. I am indebted to my advisor, Laurence Ball, for his guidance. I am grateful to Alan Ahearne, Chris Carroll, Carl Christ, Robert Davies, Hali Edison, Jon Faust, Yasuo Hirose, Michael Kiley, Takeshi Kudo, Kenneth Kuttner, Douglas Laxton, Andrew Levin, Louis Maccini, Athanasios Orphanides, Adrian Pagan, Erwan Quintin, John Roberts, Jirka Slacalek, Tsutomu Watanabe, Mark Wynne, Naoyuki Yoshino, and participants at various seminars for valuable comments and suggestions. Any errors are mine. I am an economist in the research team of the Reserve Bank of New Zealand.


It is standard to model the output–inflation trade-off as a linear relationship with a time-invariant slope. We assess empirical evidence for two sets of theories that allow for endogenous variation in the slope of the short-run Phillips curve. At an empirical level, we examine why large negative output gaps in Japan in the late 1990s did not lead to accelerating deflation but instead coincided with stable, albeit moderately negative inflation. Our results suggest that this episode is most convincingly interpreted as reflecting a gradual flattening of the Phillips curve. We find that this flattening is best explained by models with endogenous price durations. These models imply that in any economy where trend inflation is substantially lower (or substantially higher) today than in past decades, time variation in the slope of the Phillips curve has become too important to ignore.