The Bank of England published a staff working paper examining whether the Phillips curve is non-linear, finding that prices react more strongly to positive than negative shocks at the firm level and that this convexity can translate into a convex aggregate relationship between inflation and economic slack. Using micro data from large UK and US firm surveys, the paper reports consistent evidence of convex price responses across three approaches: a randomized survey experiment on hypothetical sales shocks, an analysis of sales and price forecast errors, and estimates using firms’ reported Covid-19 impacts on sales. Convexity is strongest in firms and industries with higher inflation, fades at horizons beyond two years, and is also present for cost shocks, including in a survey experiment where firms report around 60% pass-through for positive unit cost shocks versus around 20% for negative shocks. The authors rationalise these findings in a menu cost model with positive trend inflation and decreasing returns, where trend inflation leaves more firms close to their price-increase thresholds, generating non-linear price adjustment and a convex Phillips curve.
Bank of England 2025-01-10
Bank of England working paper finds firm prices respond asymmetrically to demand and cost shocks implying a convex Phillips curve
The Bank of England's staff working paper finds the Phillips curve is non-linear, with prices reacting more strongly to positive than negative shocks at the firm level, leading to a convex aggregate relationship between inflation and economic slack. Using micro data from UK and US firm surveys, the study shows consistent evidence of convex price responses, particularly in high-inflation firms and industries, and highlights a stronger pass-through for positive cost shocks. The findings are explained through a menu cost model with positive trend inflation, resulting in non-linear price adjustments.