Decoding the Phillips Curve: How Beveridgean Economics Changes Everything
"Move over traditional models, a new approach linking unemployment and inflation is here, and it's got some surprising insights for today's economy."
For decades, the Phillips curve has been a cornerstone of macroeconomic theory, illustrating the inverse relationship between inflation and unemployment. The traditional view suggests that as unemployment falls, inflation rises, and vice versa. However, recent economic events, particularly the post-pandemic period, have challenged this conventional wisdom, leading economists to question the curve's reliability.
A groundbreaking paper proposes a new perspective: the Beveridgean Phillips curve. This model, rooted in the principles of directed-search pricing, offers a fresh lens through which to understand the dynamics of inflation and unemployment. It addresses some of the shortcomings of traditional New Keynesian models, providing compelling explanations for recent economic phenomena.
The Beveridgean Phillips curve introduces novel concepts such as directed-search pricing, where prices respond to market slack rather than marginal costs. This approach leads to the 'divine coincidence,' where inflation aligns with its target rate when unemployment is at its efficient level. As we navigate an ever-changing economic landscape, the Beveridgean Phillips curve provides valuable insights for policymakers and anyone keen to understand the forces shaping our financial future.
A Tradeoff Under Scrutiny
The Phillips curve tradeoff between unemployment and price stability remains one of the most consequential ideas in macroeconomic policy, yet its practical reliability has been questioned in recent years. Inflation episodes, including the surge in the United States during the 2020s, have prompted economists to revisit whether the historical relationship still holds. Ongoing research suggests that the choice of how to measure economic slack can materially change what the curve predicts. As policymakers continue to weigh low unemployment against price stability, the shape and stability of this relationship remain an active area of debate rather than settled fact.
The New Keynesian Baseline and Its Fault Lines
The standard approach to modeling the Phillips curve rests on the New Keynesian framework, which ties inflation to monopolistic pricing and the cost of adjusting prices. In this framework, the driving variable is typically marginal cost, often proxied by measures of slack such as the unemployment rate. A widely acknowledged limitation is that there is little consensus on which measure of slack actually drives inflation, which weakens the curve's predictive power. Critics argue this ambiguity helps explain why conventional specifications have at times badly missed actual inflation outcomes.
From Bill Phillips to a Beveridgean Reformulation
The Phillips curve originated with economist Bill Phillips, who identified a relationship between unemployment and wage inflation in the macroeconomy, depicting a tradeoff between low unemployment and price stability. That empirical insight became a foundation of postwar macroeconomic thinking, though later experience eroded confidence in its stability. A recent milestone is the proposed Beveridgean Phillips curve, which models prices as responding to economic slack through directed-search pricing under price-adjustment costs, in contrast to the New Keynesian curve's reliance on marginal costs. This reformulation links the classic inflation tradeoff to labor market matching and frictions, connecting two of macroeconomics' most durable empirical regularities.
What Makes the Beveridgean Phillips Curve Different?
Unlike traditional New Keynesian models that rely on monopolistic pricing and price-adjustment costs, the Beveridgean Phillips curve is built on directed-search pricing. In simpler terms, this means that businesses set prices based on the overall slack in the economy rather than just their own costs. This approach has significant implications for how we understand the relationship between inflation and unemployment.
- The Divine Coincidence: Guarantees that inflation is on target when unemployment is efficient.
- Curve Stability: The Phillips curve shifts depending on whether it is formulated with inflation, unemployment, and labor-market tightness.
- The Kink: The Phillips curve displays a kink at the point of divine coincidence, especially if wage decreases are more costly to producers than price increases.
Putting Slack on the Test Bench
Recent work by Regis Barnichon and Adam Shapiro makes a compelling case for measuring labor market tightness using information on both unemployment and job vacancies when estimating the Phillips curve, a framework that traces out the theoretical and empirical links between the Phillips and Beveridge curves. Research from the Federal Reserve Bank of San Francisco finds there is little consensus on the forcing variable that drives inflation, and it systematically assesses which variables best predict and explain inflation fluctuations. In a separate NBER paper, researchers argue that the pre-surge consensus on both curves requires substantial revision and propose an Inverse-L New Keynesian Phillips Curve to explain the U.S. inflation surge of the 2020s. Together, these studies suggest that the measure of slack chosen is not a technicality but central to how well the curve explains recent inflation.
When the Curve Misleads
Critics of Phillips-curve modeling point to episodes where inflation rose or fell in ways standard specifications failed to anticipate, underscoring that no single measure of slack has proven reliably predictive. Because the slope and stability of the curve appear to shift across time and countries, some economists argue that conclusions drawn from estimated relationships are fragile. These failures have historically prompted repeated revisions to the framework rather than abandonment of it. As a result, healthy skepticism now accompanies any strong claim that the tradeoff can be exploited with precision.
Two Pillars of Macro, One Conversation
Comparisons between the Beveridgean Phillips curve and the standard New Keynesian Phillips curve center on what actually drives price-setting. The New Keynesian approach assumes prices respond to marginal costs under monopolistic competition, while the Beveridgean approach holds that prices respond to economic slack through directed-search pricing. Because the two formulations embed different views of market structure, they can imply different policy prescriptions for the same inflation-unemployment situation. Despite these differences, both remain attempts to reproduce the same fundamental tradeoff observed in the data.
Why This Matters for You
The Beveridgean Phillips curve offers more than just theoretical insights. It has practical implications for understanding recent economic events and shaping future policies. As economies grapple with the complexities of inflation and unemployment, this model offers a valuable tool for policymakers and analysts alike, paving the way for a more nuanced and effective approach to economic management. Whether you're an economist, a policymaker, or simply someone interested in understanding how the economy works, the Beveridgean Phillips curve provides a compelling new perspective on the forces shaping our financial world.
A New Model of Price Setting
Pascal Michaillat proposes the Beveridgean Phillips curve as a new model of the price-setting relationship at the heart of the tradeoff. Whereas the New Keynesian Phillips curve is built on monopolistic pricing with price-adjustment costs, the Beveridgean version uses directed-search pricing under the same adjustment costs, causing prices to respond to slack rather than to marginal costs. This redirected mechanism offers an alternative foundation for the aggregate supply relationship in the macroeconomy. It represents a substantive attempt to bring labor market frictions back into the core inflation framework.
Where the Research Is Heading
The likely next frontier for Phillips curve research is consolidating the empirical case for slack-based measures like labor market tightness against the traditional unemployment-based specifications. Future work may refine how tightness is measured and test whether the Beveridgean relationship holds across different economies and inflation regimes. The 2020s inflation surge appears set to serve as a natural experiment for evaluating which frameworks explain the data and which do not. Much remains uncertain, but the direction of travel is clearly toward models that integrate inflation dynamics with labor market frictions.
Inflation and Structural Frictions in the Labor Market
The Beveridgean Phillips curve situates the inflation-unemployment tradeoff within broader structural challenges, linking price dynamics to how workers and firms match in the labor market. Because it connects inflation to slack through directed-search pricing, the model makes the functioning of the labor market a driver of price outcomes rather than an afterthought. This creates a systemic view in which persistent mismatches between vacancies and unemployed workers shape inflation pressures. It reframes familiar policy debates about full employment and price stability as questions about the structure of labor markets themselves.
From a 1958 Relationship to Everyday Prices
Since the original 1958 paper linking the unemployment rate to wage inflation, a large body of theoretical work has focused on deriving foundations for the Phillips curve as the aggregate supply relationship of the macroeconomy. Behind the models sit real consequences: workers, firms, and policymakers who experience the tradeoff as tangible trade-offs between jobs and prices. Research from the Federal Reserve Bank of San Francisco underscores that how central banks identify slack shapes how they respond to rising inflation. The curve thus translates abstract economic theory into decisions that affect hiring, wages, and the cost of living.