Credit Conditions, Inflation, and Unemployment

We construct a New Monetarist model with labor market search and identify two channels that affect the long-term relationship between inflation and unemployment. First, inflation lowers wages through bargaining because unemployed workers rely more heavily on cash transactions and suffer more from inflation than employed workers: this wage-bargaining channel generates a downward Phillips curve without assuming nominal rigidity. Second, inflation increases the firm’s financing costs, which discourages job creation and increases unemployment; this cash-financing channel leads to an upward-sloping Phillips curve. We calibrate our model to the U.S. economy. The improvement in firm financing conditions can explain the observation that the slope of the long-run Phillips curve has switched from positive to negative post-2000.