For release on delivery
3:20 p.m. EST (12:20 p.m. PST)
March 1, 2024

Disinflation without a Rise in Unemployment? What Is Different This Time Around

Remarks by
Adriana D. Kugler
Member
Board of Governors of the Federal Reserve System
at the

2024 Stanford Institute for Economic Policy Research Economic Summit
Stanford University

Stanford, California

March 1, 2024

Thank you, Mark, and thank you for the opportunity to be part of the discussions
today.! For more than 40 years, the Stanford Institute for Economic Policy Research has
assisted economic policymakers by producing sharp analysis and fostering the kind of
constructive dialogue reflected in today's agenda.

My topic today is the Federal Reserve's dual mandate of maximum employment
and stable prices-and, specifically, the tradeoffs that sometimes arise when pursuing
these two objectives. I say "sometimes" because there have been times and certain
economic conditions in which such tradeoffs did not arise-or at least were not apparent.
This distinction is an important one, especially when considering the Federal Open
Market Committee (FOMC)'s recent progress in reducing high inflation while the labor
market has remained strong. Better understanding the tradeoffs, or lack thereof, in
pursuing the dual mandate will help researchers and policymakers draw lessons from
these welcome recent developments.

History of the Inflation-Unemployment Tradeoff

In 1977, Congress legislated the Federal Reserve's "dual mandate," under which
the FOMC is required to pursue both maximum employment and stable prices, with both
objectives on an equal footing." At the outset, it is worth stressing that these goals are
generally complementary, and I will return to this point shortly. But when they are not

complementary, one way to think of the policy problem is in terms of tradeoffs:

' The views expressed here are my own and are not necessarily those of my colleagues on the Federal
Reserve Board or the Federal Open Market Committee.

? Before 1977, the Federal Reserve viewed itself as having a dual mandate because it was covered by the
Employment Act of 1946, which gave the whole federal government a list of objectives that included
maximum employment and maximum "purchasing power." The predominant interpretation of the latter
objective was that it corresponded to price stability.

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Maximum employment is the highest level of employment that will not cause inflation to
escalate significantly above levels consistent with price stability.

Before going into those tradeoffs, I want to emphasize that achieving the
Committee's employment goal on an ongoing basis rests on achieving price stability.
Price stability enables long-lasting economic expansions, which strengthen the labor
market and expand employment opportunities. This process particularly benefits families
and communities that all too often have been left behind.?

But it is appropriate to recognize also that tradeoffs between the goals of
maximum employment and price stability can occur in the short term. Indeed, the
potential shorter-term tradeoff between unemployment and inflation has long featured
prominently among the economic considerations of policymakers. Government action to
boost employment through fiscal or monetary stimulus has historically tended to increase
aggregate spending and inflation, too. On the contrary, actions to reduce inflation by
shifting to contractionary fiscal or monetary policy have tended to slow economic activity
and raise unemployment, or at least slow the pace of job creation.

The idea of a short-run tradeoff is reflected in the original specification of the
"Phillips curve," named after New Zealand economist A.W. Phillips, who plotted
historical values of the United Kingdom's unemployment rate and growth in nominal

wages between 1861 and 1957, showing an often inverse relationship between the two.

3 Lopez-Salido, Markowitz, and Nelson (2024) provide a longer-term perspective on how the Federal
Reserve has viewed price stability as necessary for achieving maximum employment on a sustained basis.
See David Lopez-Salido, Emily Markowitz, and Edward Nelson (2024), "Continuity and Change in the
Federal Reserve's Perspective on Price Stability," manuscript, Board of Governors of the Federal Reserve
System, Division of Monetary Affairs, January.

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Although the Phillips curve was initially specified in terms of wages, later versions have
more typically compared unemployment with price inflation.

Taken at face value, a tradeoff between keeping employment high and reducing
inflation would seem to present policymakers with a dilemma. It suggests that when
inflation is well above levels associated with price stability, policymakers must engineer
a significant increase in unemployment to bring inflation down. Disinflation can be
especially challenging when expectations of future inflation are high.* We saw this in the
1970s and 1980s. Convincing households and businesses that the FOMC was committed
to reducing inflation required accepting a protracted, though ultimately temporary, period
of high unemployment, as then Fed Chair Paul Volcker came to believe. Volcker is
widely credited with ending the "Great Inflation" experienced at the time through his
willingness to induce a punishing recession. He lowered inflation and kept it down, in
substantial part by convincing the public that the Fed would keep inflation in check
whatever the cost, thereby lowering expectations of future inflation.°

While long experience shows that there can be a tradeoff between policy actions
to pursue maximum employment and stable prices, there are times and conditions when
this is not the case, or at least when there is little evidence of a tradeoff. For example, for

most of the decade after the Great Recession, FOMC policy was, by some measures at

4 Tn the context of achieving disinflation, the tradeoff between inflation and unemployment is sometimes
referred to as the "sacrifice ratio." Estimates of the quantitative magnitude of this ratio vary widely,
depending on the period being studied and the nature of the macroeconomic model being used. Model-
based explorations do suggest that inflation expectations matter for the size of the ratio. For a helpful
discussion and analysis, see Robert J. Tetlow (2022), "How Large Is the Output Cost of Disinflation?"
Finance and Economics Discussion Series 2022-079 (Washington: Board of Governors of the Federal
Reserve System, November), https://www. federalreserve.gov/econres/feds/files/2022079pap.pdf.

5 See David E. Lindsey, Athanasios Orphanides, and Robert H. Rasche (2005), "The Reform of October
1979: How It Happened and Why," Federal Reserve Bank of St. Louis, Review, vol. 87 (March/April,
Part 2), pp. 187-235, https://doi.org/10.20955/r.87.187-236.

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least, highly accommodative, yet inflation ran consistently below the Committee's 2
percent target. So when inflation is below target and employment is below maximum
sustainable levels, accommodative policy can be used to pursue both sides of the
mandate.

Academic economists have debated for decades about the circumstances in which
the tradeoff applies. One strand of the research literature proposes that a central bank can
indeed achieve good economic outcomes by focusing on a single mandate, an inflation
target, and that policies to promote stable prices can also secure low unemployment. In
this view, stabilization of inflation ensures that the economy performs at its optimal level,
with firms producing just the right amount such that no resources, including workers, are
left on the sidelines. This theory fits in a world in which the economy is driven by
demand-in such a case, shocks coming from the demand side of the economy can be
offset by monetary policy, which works via aggregate demand.°

But in the real world-which is not so simple-demand shocks are not the only
forces that can drive economic fluctuations. Supply shocks not only exist, but they can
also be large and persistent, as we have learned over the past several years. Adverse
supply shocks, just like higher inflation expectations, make managing the tradeoff
between inflation and unemployment more difficult and costly. While a sharp reduction
in demand reduces both economic activity and inflation, a sharp reduction in supply, such

as a sudden loss of global oil supply, increases inflation and reduces economic activity.

6 For discussion of the notion that inflation-targeting monetary policy can achieve both stable prices and
maximum employment, see Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin, and Adam S. Posen
(1999), Inflation Targeting: Lessons from the International Experience (Princeton, N.J.: Princeton
University Press). More recently, this notion has been called the "divine coincidence" (see Olivier
Blanchard and Jordi Gali (2007), "Real Wage Rigidities and the New Keynesian Model," Journal of
Money, Credit and Banking, vol. 39 (February), pp. 35-65).

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Trying to combat inflation by raising interest rates would further reduce economic
activity and employment, while reducing interest rates to boost economic activity and
employment raises inflation even higher. Therefore, counteracting a persistent supply
shock with monetary policy tools may help with one side of the mandate but create even
larger deviations from the other side of the mandate.

Inflation and Unemployment in the Pandemic and Its Aftermath

Let me now turn to the pandemic experience. Inflation picked up in 2021, and by
mid-2022, 12-month inflation, based on personal consumption expenditures (PCE), hit
7 percent, well above the FOMC's 2 percent target. It was the most significant surge in
inflation since the 1970s, prompting fears that it could raise expectations of future
inflation and make getting inflation down again require a steep tradeoff-that is, much
higher unemployment.

One more specific concern was that a so-called wage--price spiral would emerge,
as may have been the case for a time in the 1970s. In a tight labor market, expectations
of continued high inflation can lead workers trying to maintain their living standards to
demand higher raises. In a context of strong aggregate demand, firms will likely grant
the wage increases to retain their workers-then pass through the resulting cost increase
as higher prices. To avoid a continuing spiral, demand and supply in labor and product
markets must be rebalanced-through lower aggregate demand, greater aggregate supply,
or both.' If achieving this balance requires a drastic reduction in aggregate demand, then

sustainably taming inflation could require a high cost in terms of the employment

7 For a discussion of wage-price spirals, see Ben S. Bernanke (2006), "The Benefits of Price Stability,"
speech delivered at the Center for Economic Policy Studies and on the occasion of the Seventy-Fifth
Anniversary of the Woodrow Wilson School of Public and International Affairs, Princeton University,
Princeton, N.J., February 24, https://www.federalreserve.gov/newsevents/speech/bernanke20060224a.htm.

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mandate. Fortunately, we appear to have avoided a wage-price spiral this time, as I will
discuss later.

As inflation rose and began to appear persistent, the FOMC rightly focused on
restoring price stability, knowing that without price stability, the economy would not
work for anyone and that high inflation would ultimately undermine the strength of the
labor market. While interest rates rose rapidly, some feared that the cost of disinflation
would be persistently elevated unemployment. But over the past year or so, that tradeoff
has been much less evident than many feared. We have seen inflation cool significantly,
falling more rapidly than at any time since the 1980s. Yet unemployment remains near
the lowest levels seen only a few times since the 1960s.

How have we managed to avoid the familiar tradeoff during this period and see
such welcome outcomes on both the inflation and employment fronts? I would propose a
few possible reasons. These center on the fact that the pandemic inflation featured both
supply and demand shocks. In the limited time that I have today, I don't propose to get
into the debate about exactly how much of the recent inflation can be explained by supply
as opposed to demand. But I will discuss how both demand and supply forces have been

important in the rise and fall in the inflation rate.®

8 Precisely quantifying the relative roles of supply and demand in the pandemic inflation will likely remain
a controversial pursuit for some time. One approach is to focus on relative movements of particular prices
and of specific output categories in a "bottom up" manner, as illustrated, for example, by Adam Hale
Shapiro (2022), "Decomposing Supply and Demand Driven Inflation," working paper, Federal Reserve
Bank of San Francisco, February. An alternative approach is to conduct a "top down" time-series analysis
relating aggregate data on wages, prices, labor market tightness, and various measures of goods supply
conditions, as illustrated by Olivier J. Blanchard and Ben S. Bernanke (2023), ""What Caused the U.S.
Pandemic-Era Inflation?" NBER Working Paper Series 31417 (Cambridge, Mass.: National Bureau of
Economic Research, June), https://www.nber.org/papers/w3 1417. The two approaches can complement
each other by providing alternative, but mutually consistent, perspectives on the same problem.

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The pandemic caused a significant reduction in supply in some areas of the
economy. Limits on the supply of goods resulted from restricted output in many
industries. Consider a key U.S. manufacturing industry, auto production. In 2019, the
U.S. manufactured 10' million light vehicles. In 2020, production plunged to
8 million, with pandemic-related plant shutdowns followed by worldwide shortages of
computer chips and other parts.' It has taken the industry a long time to recover-auto
production was less than 9 million in 2021 and a bit under 10 million in 2022.
Constrained vehicle supply played a big role in boosting auto prices. And it wasn't just
motor vehicles; for example, you might recall reports of food processing plant
shutdowns, and many other goods-producing industries also suffered from "lost output."
U.S. industrial production dropped at the onset of the pandemic and then remained below
its pre-pandemic level until early 2022 despite strong demand for physical goods; indeed,

evidence shows that output was held down by insufficient supply of materials. '°

° The auto industry's experience during the pandemic is a good example of how many industries'
production functions are, in economists' terms, "Leontief," meaning that shortages of even one key
component can restrict production even if other components are available. The prevalence of this kind of
production in many industries made the broader supply chain particularly vulnerable to the extreme
pandemic supply shocks. A helpful discussion-which predates the pandemic and focuses on the 2011
Japan earthquake-is Christoph E. Boehm, Aaron Flaaen, and Nitya Pandalai-Nayar (2019), "Input
Linkages and the Transmission of Shocks: Firm-Level Evidence from the 2011 Tohoku Earthquake,"
Review of Economics and Statistics, vol. 101 (March), pp. 60-75.

'0 Industrial production was low despite strong demand: New orders indexes from many sources were
elevated throughout late 2020 and 2021. The Census Bureau's Quarterly Survey of Plant Capacity
Utilization features questions on reasons for factory output being below capacity. "Insufficient supply of
materials" and "insufficient supply of labor" both surged starting in late 2020 and remained near peak
levels from mid-2021 through mid-2022 before starting to move back down. Separately, the Institute for
Supply Management's Report on Business Manufacturing PMI (Purchasing Managers Index) features lists
of items in short supply each month; the share of major manufacturing-sector input material groups
reported as being in short supply surged to about 40 percent during 2021 and has since declined to below
10 percent. For a more formal approach to measuring lost output in manufacturing industries, see Charles
Gilbert, Maria D. Tito, and Cynthia Doniger (2021), "Quantifying Bottlenecks in Manufacturing," FEDS
Notes (Washington: Board of Governors of the Federal Reserve System, November 19),
https://www.federalreserve.gov/econres/notes/feds-notes/quantifying-bottlenecks-in-manufacturing-
20211119.html.

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But supply problems were not limited to goods; indeed, insufficient supply of
labor has also been widely cited by businesses as having held down output. Labor supply
was suddenly and severely limited early in the pandemic as workers voluntarily and, in
some cases, involuntarily stayed out of the workplace. The labor force did not recover to
pre-pandemic levels until mid-2022. Older workers, in particular, left the labor market in
large numbers. But even many prime-age workers-those between the ages of 25 and
54--withdrew because of school disruptions and health concerns, and prime-age labor
force participation remained below its pre-pandemic level until early 2023. A slowdown
in immigration, likewise, deprived the economy of a customary source of labor supply
growth, as did elevated mortality due to COVID-19."!

Fortunately, these supply shortages for both goods and labor have mostly
dissipated. For example, auto production in 2023 nearly regained its 2019 level, and
industrial production as well as various goods supply indicators have returned closer to
their pre-pandemic levels. Congestion in logistics and transportation networks eased, and
firms sometimes found alternative supply chain networks.

In the labor market, shortages directly related to the pandemic have eased, helping
restore labor force participation, likely in part because of the reopening of schools,
progress with the health situation, and help from childcare subsidies and other policies.
Increased capabilities for remote work, allowing for a decoupling between firm and
worker location, expanded the pool of available workers and jobs. More broadly, strong

labor demand has enticed more workers into the labor market to the point that labor force

"I Per data from the Bureau of Labor Statistics Current Population Survey, the labor force level among
foreign-born workers had a pre-pandemic peak about a year before the pandemic and did not fully recover
to this peak until early 2022.

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participation among prime-age workers is now above pre-pandemic levels. And
immigration has rebounded as well.

Another, more subtle source of labor market supply recovery has been
improvements in the quality of matches between firms and workers. At any time, a
crucial factor that affects labor supply is how well the skills of available workers fulfill
the needs of employers. With labor in many sectors in short supply and very high
numbers of job openings, many workers quit their jobs to move to new ones. Economists
generally believe that increased labor turnover improves worker-firm matches-workers
find jobs that make better use of their skills, typically with higher pay, and firms find
workers that are better suited for their businesses and are more productive at their jobs.
Economic expansions, such as the one that has continued since April 2020, present more
opportunities for workers to find a good match.!? And it appears that workers and firms
were pretty efficient at finding each other over the past couple of years, likely upgrading
the average quality of a job match in the process.'? Higher-quality job-worker matches
improve the productivity of workers, serving like a boost to labor supply.

If reductions in supply contributed to inflation, then recovery of that supply would

help lower inflation, too. Supply improvements in the goods sector have helped ease

'2 Past research has found that job quality is higher in expansions; see Gadi Barlevy (2002), "The Sullying
Effect of Recessions," Review of Economic Studies, vol. 69 (January), pp. 65-96. In the pandemic
specifically, job-to-job flows appear to have featured strong wage growth; see David Autor, Arindrajit
Dube, and Annie McGrew (2023), "The Unexpected Compression: Competition at Work in the Low Wage
Labor Market," NBER Working Paper Series 31010 (Cambridge, Mass.: National Bureau of Economic
Research, November), https://www.nber.org/papers/w3 1010.

'3 There are various ways to measure "matching efficiency." One such measure shows an initial decline in
matching efficiency early in the pandemic, followed by a recovery to (roughly) pre-pandemic levels. See
Simon Mongey and Jeff Horwich (2023), "Are Job Vacancies Still as Plentiful as They Appear?
Implications for the 'Soft Landing,' " Federal Reserve Bank of Minneapolis, December 1,
https://www.minneapolisfed.org/article/2023/are-job-vacancies-still-as-plentiful-as-they-appear-
implications-for-the-soft-landing.

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inflation starting in early 2022; for example, in January, the 12-month growth of new
motor vehicle prices was less than I percent, far slower than its peak pace above 13
percent in the spring of 2022. More broadly, the overall price level for core PCE goods,
which excludes food and energy, was fairly flat last year and has actually declined in
recent months.

On the labor side, supply recovery has likely contributed to disinflation by
helping to ease the pace of wage growth-especially in the labor-intensive services
industries.'* For private services as a whole, 12-month nominal wage growth, as
measured by average hourly earnings, was 4.5 percent in January, down from its peak of
5.9 percent in early 2022. And, sure enough, price inflation in services has also slowed:
In core PCE services-which accounts for roughly three-fourths of core PCE-12-month
inflation was 4.1 percent in January, down from its peak of 5.8 percent early last year.!>

But supply is not the only factor behind the slowing of inflation. Policies
affecting aggregate demand have played a role as well. On the fiscal side, measures of
the impact of government spending on economic growth turned negative in 2021 after
being strongly supportive in 2020.'° And in terms of monetary policy, the FOMC's

actions in late 2021 indicated a sooner-than-previously-anticipated start to policy rate

'4 Tn general, the most labor-intensive sectors (measured as labor costs' share of value added) are mostly
services sectors. As of 2022, the labor cost share of value added was 83 percent in education and health
services, 75 percent in professional and business services, 64 percent in construction, and 59 percent in
leisure and hospitality. See Bureau of Economic Analysis (2023), "Interactive Data," tables on
composition of gross output by industry," December,
https://apps.bea.gov/iTable/?reqid=150&step=2&isuri=1 &categories=gdpxind.

'S The connection between wages and prices in services industries has been explored in the economics
literature and been found to be a likely contributor to the higher "stickiness" or persistence of services
prices relative to goods prices. See Ekaterina Peneva (2011), "Some Evidence on Factor Intensity and
Price Rigidity," Journal of Economic Dynamics and Control, vol. 35 (October), pp. 1652-58.

'6 See, for example, the Hutchins Center Fiscal Impact Measure, which estimates the effect of government
tax and spending policy on gross domestic product growth. The measure is available on the Brookings
Institution's website at https://www.brookings.edu/articles/hutchins-center-fiscal-impact-measure.

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increases, with the FOMC beginning to raise the target range for the federal funds rate in
March 2022. After that, the Committee tightened its stance of policy expeditiously. The
result can be seen especially in areas of the economy that are sensitive to financial
conditions. The housing sector saw a significant slowdown, with residential investment
declining more than 15 percent in 2022 and remaining flat in 2023. Growth of
investment in equipment was tepid last year, likely due in part to restrictive financial
conditions, even as we have seen growth in manufacturing construction for
semiconductors and electric vehicle batteries that will help address remaining supply-side
bottlenecks.

Aside from these examples of subdued spending in policy-sensitive sectors, we
can also see the imprint of monetary policy in the anchoring of inflation expectations.
Even amid high inflation, households, businesses, and financial markets believed that
inflation would eventually return to its target pace. These beliefs were guided by the
FOMC's actions: By raising policy rates expeditiously and communicating clearly, the
Committee demonstrated its resolve to lower inflation to 2 percent and its commitment to
the price-stability mandate. Anchored inflation expectations are apparent, for example, in
the popular University of Michigan Surveys of Consumers. Expectations of inflation for
the period covering the next 5 to 10 years have remained relatively stable over the
pandemic and close to levels seen before the pandemic. And shorter-term expectations
rose in 2021 but have come back down recently.!? Anchored inflation expectations likely

matter for actual price setting. That is what modern theories of the Phillips curve

'7 Expected inflation in the New York Fed's Survey of Consumer Expectations shows a similar pattern to
that seen in the Michigan survey. And expectations appear well anchored in surveys of forecasters and in
market-based measures.

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suggest. And the relevance of that theoretical expectation has been suggested by surveys
reported by Federal Reserve Bank of Richmond staff: The data show a close relationship
between firms' expectations for overall inflation and those firms' own price-setting
plans.'® Crucially, by keeping inflation expectations anchored, the FOMC has likely
forestalled the development of wage-price spiral dynamics of the kind I mentioned
earlier, while also creating conditions in which inflation has been able to peak at a lower
rate than would have been the case if the FOMC had not acted with credibility and clear
communication. Real wage growth-that is, growth of wages after accounting for
inflation-has turned positive, which means workers' income is rising faster than the cost
of living.
A Couple of Final Observations about the Pandemic and Its Aftermath

These developments help bring us back to the inflation-unemployment tradeoff
that started my discussion. The pandemic experience has shown that the nature of that
tradeoff changes with economic conditions, as does the steepness of the Phillips curve. I
will close by making two more general observations about the changes that we have seen
during the pandemic and its aftermath, with suggestions about open questions for
researchers moving forward.

First, supply curves are, as economists say, "convex": Their slope increases
sharply after quantity supplied reaches a certain point, such that prices rise quickly. The
steep part of the supply curve can come into play when demand nears the limits of an

industry's capacity. That could happen either because of an unusually large increase in

'8 See Felipe F. Schwartzman and Sonya Ravindranath Waddell (2024), "Inflation Expectations and Price
Setting among Fifth District Firms," Economic Brief 24-03 (Richmond, Va.: Federal Reserve Bank of
Richmond, January), https://www.richmondfed.org/publications/research/economic_brief/2024/eb_ 24-03.

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demand or because of a temporary reduction in industry capacity-or both. Research has
shown this is the case for individual industries, even in the pre-pandemic period."
During the pandemic, many industries experienced large demand shocks or supply
curtailment that contributed to inflation, as I have already discussed, and those same
shocks also may have exacerbated the inflationary effects by pushing many industries up
the steep part of their supply curves."°

Early in the pandemic, the convexity or steepness of industry supply curves was
quite costly in terms of our inflation mandate. But it has likely helped us more recently
as we have apparently moved back down the steep part of the supply curve in many
industries, which has allowed for rapid disinflation.?!_ An open question in the longer
term is whether this process has helped firms learn more about supply chains and
inventory management such that we might even be less likely to encounter the steep part
of supply curves in the future.

Second, with regard to the Phillips curve specifically, I note that in a large class of
economic models, the steepness of the Phillips curve is partly a function of how

frequently firms adjust their prices, and that seems to be borne out by recent experience."

'S See Christoph E. Boehm and Nitya Pandalai-Nayar (2022), "Convex Supply Curves," American
Economic Review, vol. 112 (December), pp. 3941-69.

20 For an accessible discussion, see Deepa D. Datta, Laura Feiveson, Ekaterina Peneva, and Gisela Rua
(2022), "Bottlenecks, Shortages, and Soaring Prices in the U.S. Economy," FEDS Notes (Washington:
Board of Governors of the Federal Reserve System, June 24),
https://www.federalreserve.gov/econres/notes/feds-notes/bottlenecks-shortages-and-soaring-prices-in-the-
us-economy-20220624.html.

21 For a formal treatment of the notion that monetary policy can be particularly effective at lowering
inflation without large output losses following supply and capacity issues, see Xiwen Bai, Jesus Fernandez-
Villaverde, Yiliang Li, and Francesco Zanetti (2024), "The Causal Effects of Global Supply Chain
Disruptions on Macroeconomic Outcomes: Evidence and Theory," working paper, January, available on
the University of Pennsylvania website at
https://www.sas.upenn.edu/~jesusfv/Supply_Chain_Disruption.pdf.

22 In a broad set of models on inaction and action in the face of uncertainty and "non-convex" adjustment
costs, firms may choose not to change prices even when faced with shocks, provided the shocks are small.

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Before the pandemic, the typical price tag lasted more than 10 months, and this figure
was reasonably stable for many years. But the pandemic seems to have moved firms into
a regime of more frequent price adjustment-that is, shorter price duration. By early
2022, the typical price was lasting less than five months. Price adjustment frequency has
since slowed back down, with the latest data from the third quarter of last year suggesting
prices were lasting nearly seven months."? Continued slowing of price adjustment
frequency is an indicator that firms' costs are rising less quickly and the economy is
moving back down the Phillips curve."* Interestingly, though, in the workhorse academic
models used for studying the effects of monetary policy on the economy, the frequency
of price adjustment is often assumed to be constant. Of course, economists have thought
about this in the past; but a greater understanding of the relationship between the price
adjustment decisions of individual firms and overall inflation is an important area for

further academic research.»

But large shocks move firms out of their "inaction range" such that a series of large shocks can increase
adjustment frequency. This can potentially explain reduced price "stickiness" in the pandemic. However,
this outcome was not necessarily inevitable, as higher uncertainty can reduce adjustment frequency (due to
raising the "real option" value of waiting), and the pandemic environment has been uncertain in many
dimensions. For discussions, see Joseph Vavra (2014), "Inflation Dynamics and Time-Varying Volatility:
New Evidence and an Ss Interpretation," Quarterly Journal of Economics, vol. 129 (February), pp. 215-58;
and Robert E. Hall (2023), "A Major Shock Makes Prices More Flexible and May Result in a Burst of
Inflation or Deflation," NBER Working Paper Series 31025 (Cambridge, Mass.: National Bureau of
Economic Research, March), https://www.nber.org/papers/w3 1025.
23 See updated data from Hugh Montag and Daniel Villar (2023), "Price-Setting during the Covid Era,"
FEDS Notes (Washington: Board of Governors of the Federal Reserve System, August 29),
https://www.federalreserve.gov/econres/notes/feds-notes/price-setting-during-the-covid-era-
20230829. html.
4 The previous inflationary episode experienced by the U.S.-during the late 1970s and early 1980s-saw
similar dynamics of price adjustment frequency; see Emi Nakamura, Jon Steinsson, Patrick Sun, and Daniel
Villar (2018), "The Elusive Costs of Inflation: Price Dispersion during the U.S. Great Inflation," Quarterly
Journal of Economics, vol. 133 (November), pp. 1933-80.

251 am referring here to the standard "New Keynesian" model, in w