As presented in international literature, some of these explanations are: de-anchoring inflationary expectations, the labor market slack, a lower natural rate of unemployment, changes in expectations regarding the real pay growth, the decoupling between growth and inflation, the role of global value chains 1  in keeping prices down, the role of migration in keeping wages down in the countries of destination, and others. While there is some truth in each and every of them, no alternative has been successfully suggested so far. I think that the Phillips Curve needs a reality-check. If we want to explain inflation, we need to make some adjustments to the Phillips curve. The following presentation is based on two working papers that I recently published with Center for European Policy Studies (CEPS)i, respectively and Global Labor Organization (GLO)ii. Three major changes are needed to the Phillips curve. First, we should work with observable variables only. The problem with econometric models which use non-observable variables is built-in: they tend to under-perform in bad times. Potential GDP is revised retroactively. The output gap depends on potential GDP. Plus, an economy can grow above its potential without being at its full employment (in particular, but not exclusively, in catching-up economies). Any measure of unemployment is controversial, given the impact of insufficiently accounted factors such as the underground economy, migration, inactivity, part-time employment. A nonobservable measure of unemployment, like NAIRU, is even more debatable. If Central Banks rest their decisions solely on such non-observable variables, they are at risk of getting them wrong.
In addition, corporations or organisations in this new environment can no longer function by departments or sections, but as an integrated organisation. This also requires new governance arrangements. For an economy or a financial system, we have seen how a crisis in one segment was thought to be confined, but it had pervasive consequences on the entire financial system and the economy. Sixth, is that despite the increased connectivity of the world, as exemplified by the swift spread of the financial crisis and economic shocks throughout the global economy and international financial system in 2008, the institutional arrangements for the cross-border dimension of policy-making have yet to reach the levels commensurate with the degree of economic and financial integration in the world. Finally, the response to the crisis needs to be comprehensive. While addressing the weaknesses and lapses is important, equally important is the enabling environment for the measures to yield results. Pro-growth policies are vital for this purpose. During the Asian financial crisis, Malaysia gave equal attention to financial sector resolution to restore the financial intermediation process and thus credit supply. Equally emphasis was placed on addressing the problems of borrowers. Debt restructuring and mechanisms for support were put in place for the corporate sector, small and medium-scale enterprises and the household sector. This supported growth of the economy and at a fraction of the cost of the financial sector resolution.