The Stability of the Phillips Curve

An analysis of data from the United States and the United Kingdom supports the view that the traditional Phillips curve is unstable over time. The first stability test suggests that there is weak evidence of stability in the inflation-unemployment trade-off. Three out of four stability tests suggest that the Phillips curve is stable over the examined time period. However, the out-sample dynamic simulation test fails to predict an inflation pattern during the Global Financial Crisis. The second stability test strongly rejects the evidence of symmetry in the inflation-output relationship. The L-shaped Phillips equation outperforms the other non-linear and linear models, despite a very small difference in the R-squared and the Log-Likelihood function. The failure in the Phillips curve throughout the examined time period illustrates that relying on the statistical relationships between inflation and unemployment/output is not enough to formulate a proper monetary policy, especially during large economic shocks.