Explaining the Recent Behavior of Inflation and Unemployment in the United States

IMF Working Papers, September 1, 1998

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Low rates of inflation have been recorded in recent years, despite a decline in the unemployment rate.
The phenomenon could reflect either a series of transitory shocks or a permanent change in the structure of the economy leading to a lower NAIRU.
The paper suggests that, while the NAIRU may have fallen slightly, it has not fallen by an amount sufficient to explain the recent behavior of inflation.
A leading explanation for recent inflation performance appears to be favorable price shocks; in particular, the cost of imports has fallen sharply as the dollar has appreciated.

NAIRU may have declined slightly, but the magnitude of the decline is insufficient to account for observed low inflation given the decline in unemployment.
The observed pattern implies that standard NAIRU-based Phillips curve explanations overpredict inflation unless other forces are at work.
Key labor-related subjects noted: Labor, Labor costs, Unemployment, Unemployment rate, unemployment gap.

Favorable price shocks are identified as a primary explanation for subdued inflation.
In particular, the cost of imports has fallen sharply as the dollar has appreciated.
Subject and keyword emphasis: Import prices, Prices, Import prices, inflation performance, inflation variable.

Attribution of low inflation to transitory favorable price shocks suggests that underlying inflationary pressures tied to labor market slack may be larger than headline inflation implies.
If import-price-driven disinflation is temporary, inflation could rise if the import-price effect reverses or if the NAIRU proves higher than implied by recent inflation outcomes.
Policy assessments should account for the distinction between structural changes in NAIRU and temporary external price shocks when evaluating labor market tightness and inflation forecasts.

Explaing the recent Behavior of Inflation and Unemployment in the United States - WP/98/145
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