Low-inflation Targeting and Long-run Unemployment

Abstract

The model of Akerlof, Dickens and Perry (2000) (ADP) predicts that low inflation may cause unemployment to persist at high levels. When applied to U.S. data, their results strongly rejected the conventional NAIRU model. We apply the ADP model to Swedish data. The fact that our Swedish data also reject the NAIRU model has a number of interesting implications for the Swedish economy and, potentially, for other European countries as well. The results indicate that raising the Swedish inflation target from 2 to 4 percent would bring long-run unemployment down by several percentage points. The possibility of ADP-type long-run Phillips curves also across the euro countries may raise some concern about the EMU project. While detailed studies on other countries are needed, there is nothing to suggest that these non-vertical Phillips curves would not differ considerably across the euro countries. Any single inflation level targeted by the ECB would then generate excess unemployment in individual member states.