Dissecting the Phillips Curve: Evidence from Cross-Sectional Heterogeneity and Regime-Dependent Nonlinearity

Accurately estimating the Phillips curve remains a significant methodological challenge. Recent panel data approaches reveal substantial cross-sectional heterogeneity, raising doubts about pooled estimates. This paper develops a novel group-based approach that systematically accounts for unobserved heterogeneity in the regional Phillips curve. We identify two distinct groups of U.S. states: one with a steep, significant Phillips curve, and another with a flat, insignificant relationship. Our results show that regional heterogeneity persists across regimes, with parameter nonlinearity emerging during recessions. Much of the flattening of the Phillips curve is region-specific, indicating the importance of both heterogeneity and nonlinearity in Phillips curve dynamics.