The unemployment–inflation trade-off revisited: The Phillips curve in COVID times

Using a New Keynesian Phillips curve, we document the rapid and persistent increase in the natural rate of unemployment, $u_t^{\ast }$, in the aftermath of the pandemic and characterize its implications for inflation dynamics. While the bulk of the inflation surge is attributed to temporary supply factors, we also find an important role for current and expected negative unemployment gaps. Through the lens of the model, the 2022–2023 disinflation was driven by the expectation that the unemployment gap will close through a progressive decline in $u_t^{\ast }$ and a rise in the unemployment rate. This implies that convergence to long-run price stability depends, critically, on expectations about labor market tightness. Using a variety of cross-sectional data sources we provide corroborating evidence of unusually tight labor market conditions, consistent with our estimated rise in $u_t^{\ast }$.