Number of hits for “financial frictions” in EconLit 100  100  90  90  80  80  70  70  60  60  50  50  40  40  30  30  20  20  10  10  0  0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12  10  BIS central bankers’ speeches  References Banerjee, R., S. Cecchetti and B. Hofmann, (2013), “Flexible inflation targeting: Performance and challenges”, in Reichlin, L. and R. Baldwin, (ed. ), “Is Inflation Targeting Dead? Central Banking After the Crisis”, Centre for Economic Policy Research. Bean, C., (2013), “Nominal income targets: an old wine in a new bottle”, speech at the Institute for Economic Affairs Conference on the State of the Economy, London, 27 February. Bech, M.L., L. Gambacorta and E. Kharroubi, (2012), “Monetary policy in a downturn: Are financial crises special?”, BIS Working Papers No. 388. Bernanke, B.S.,T. Laubach, F.S. Mishkin and A.S. Posen (1999), Inflation Targeting – Lessons from the International Experience, Princeton University Press. Bernanke, B.S., (2004), “The Great Moderation”, speech at the Eastern Economic Association, Washington, 20 February. Bini Smaghi, L., (2013) “Who killed the inflation target?”, in Reichlin, L. and R. Baldwin, (ed. ), “Is Inflation Targeting Dead? Central Banking After the Crisis”, Centre for Economic Policy Research. Brunnermeier, M.K., T.M. Eisenbach and Y. Sannikov, (2012), “Macroeconomics with Financial Frictions: A Survey”, NBER Working Paper 18102.
This development has caused some analysts to talk about “the missing deflation”.5 The so-called Phillips curve, which shows the relationship between the rate of inflation and economic activity, appears to have flattened compared with before.6 One possible explanation for this development is that the monetary policy conducted in recent decades around the world – where independent central banks have primarily focussed on attaining low and stable inflation – has gradually succeeded in anchoring inflation and inflation expectations. This has meant that the Phillips curve has stabilised in a situation with low average inflation. It is not entirely clear why this would also have contributed to reducing the slope of the Phillips curve, but we cannot rule out the possibility that if expectations are anchored better, price-setting and wage formation will be less sensitive to changes in economic activity. So, even if a monetary policy aimed at keeping inflation low and stable was perhaps not the main explanation for the Great Moderation, it is possible that it made an enduring impression in the form of a flatter Phillips curve. We cannot know whether this phenomenon is temporary or permanent. But if it is the case that we have had a fundamental change in the way the economy functions, it is also possible that this should lead to the central bank adapting, at least to some extent, the policy it conducts. A flatter Phillips curve implies that inflation has become less sensitive to the domestic demand situation – that it varies less with cyclical phases.