Working Paper

Post-COVID Inflation Dynamics: Higher for Longer

Abstract: In the December 2022 Summary of Economic Projections (SEP), the median projection for four-quarter core PCE inflation in the fourth quarter of 2025 is 2.1 percent. This same SEP has unemployment rising by nine-tenths, to 4.6 percent, by the end of 2023. We assess the plausibility of this projection using a specific nonlinear model that embeds an empirically successful nonlinear Phillips curve specification into a structural model, identifying it via an underutilized data-dependent method. We model core PCE inflation using three components that align with those noted by Chair Powell in his December 14, 2022, press conference: housing, core goods, and core-services-less-housing. Our model projects that conditional on the SEP unemployment rate path and a rapid deceleration of core goods prices, core PCE inflation moderates to only 2.75 percent by the end of 2025: inflation will be higher for longer. A deep recession would be necessary to achieve the SEP’s projected inflation path. A simple reduced-form welfare analysis, which abstracts from any danger of inflation expectations becoming unanchored, suggests that such a recession would not be optimal.

Keywords: Nonlinear Phillips Curve; Frequency Decomposition; Supply Price Pressures; Structural VAR; Nonlinear Impulse Response Functions; Welfare Analysis;

JEL Classification: E31; E32; E52; C32;

https://doi.org/10.26509/frbc-wp-202306

Bibliographic Information

Provider: Federal Reserve Bank of Cleveland

Part of Series: Working Papers

Publication Date: 2023-01-13

Number: 23-06

Related Works

• Working Paper Revision: Post-COVID Inflation Dynamics: Higher for Longer