Inflation-unemployment Tradeoff Research Articles

Inference and Forecasting Based on the Phillips Curve

In this paper, we conduct uniform inference of two widely used versions of the Phillips curve, specifically the random-walk Phillips curve and the New-Keynesian Phillips curve (NKPC). For both specifications, we propose a potentially time-varying natural unemployment (NAIRU) to address the uncertainty surrounding the inflation-unemployment trade-off. The inference is conducted through the construction of what is known as the uniform confidence band (UCB). The proposed methodology is then applied to point-ahead inflation forecasting for the Korean economy. This paper finds that the forecasts can benefit from conducting UCB-based inference and that the inference results have important policy implications.

NAIRU Estimates for Germany: New Evidence on the Inflation–Unemployment Tradeoff

AbstractMeaningful estimates of the non-accelerating inflation rate of unemployment (NAIRU) within a Phillips curve framework require an identified tradeoff between inflation and unemployment. However, observations of inflation and unemployment are equilibrium points giving rise to a simultaneity problem. We assess conventional identifying assumptions in the literature on the German NAIRU in a general bi-variate equations system of inflation and unemplyoment. We use a data-driven method for identification based on shifts in the relative volatility of shocks to unemployment and inflation to identify the tradeoff for Germany. Our results support models which estimate a contemporaneous effect of unemployment on inflation and those which model inflation and unemployment jointly.

Flexible inflation targeting and labor market inefficiencies

Do congestion externalities offer a reason to depart from complete price stability as the only goal of monetary policy in a New Keynesian model featuring search frictions, and under what conditions is the welfare cost of labor-market distortions sizable? This paper tries to answer these questions by deriving a linear quadratic framework for optimal monetary policy analysis – ala Benigno and Woodford (2005) – that is consistent with a Pareto inefficient labor market allocation, where the Hosios (1990) condition is not satisfied, and as a consequence, the flexible-price steady state of the model is distorted. The results indicate that maximization of expected utility of the representative household is equivalent to minimizing a quadratic loss function that consists of inflation, and two appropriately defined gaps involving unemployment and labor market tightness; and that search externalities give rise to an endogenous cost-push term in the New Keynesian Phillips Curve. Hence, full stabilization of both inflation and the welfare relevant unemployment gap is not feasible and deviation from complete price stability is welfare improving (because it allows to contain inefficient unemployment fluctuations). The inflation-unemployment trade-off and the welfare cost of search externalities are shown to be quantitatively sizable in response to shocks when steady state distortions are large and thereby the cost-push term is more volatile over the business cycle. Finally, a monetary policy rule that responds to unemployment growth rate is presented to be more efficient than a rule responding to unemployment gap.

The Naive Central Banker

There has been in some countries a trend of assigning other functions to central banks besides price stability. The most suggested function to be added to monetary authority’s obligations is to pursue economic growth or full employment. In this paper we characterize the behavior and analyse the optimal monetary policy of, what we call, a naive central banker. We describe the naive behavior as one that does face the inflation-unemployment trade-off, but it tries to minimize both variables simultaneously. Our findings, both under discretion and commitment, indicate that the naive central banker delivers lower expected inflation and inflation variance than the benchmark behavior whenever the economy is rigid enough. However, the degree of conservativeness also affects this result, such that the less conservative the naive policymaker, the more rigidity is necessary.

A comparison of the dynamics of inflation in the USA and Japan: a VAR-VEC analysis

This paper examines inflation dynamics in the USA and Japan from 1980Q1 to 2013Q2. Changes in inflation, unemployment, output gap and policy interest rate behaviours during the last Great Recession that hit the US and Japanese economies are considered. According to a vector autoregression and VEC analyses, we found that even if there is evidence that inflation and unemployment are I (1), there is not a long–run inflation-unemployment tradeoff for the USA. Surprisingly, a short–run inflation-unemployment trade–off is very weak in Japan. This study is consistent with the opinion that the relationship between these two variables is not stable in either the short run nor in the long run: unemployment shows Granger causality with inflation but the opposite is not true in the USA. There is no Granger causality for Japan. We also find evidence that monetary policy lost its power in the US and Japanese real economies after the 2008 crisis.

The Inflation–Unemployment Trade-Off Under Stagflationary Conditions: The Case of Post-Revolution Iran

In this paper, we estimate a Phillips Curve model for Iran in which expectations of inflation are formed both adaptively and rationally. We measure a significant trade-off between inflation and unemployment. Our results suggest that reaching the five-year plan’s “target” unemployment rate of 7% will accelerate the inflation rate to more than 30%. Likewise, arriving at the plan’s “target” inflation rate of 12% will increase the unemployment rate to about 18%. Given such a trade-off, the plan’s target of achieving lower unemployment rate and slower inflation rate is not feasible. In the oil-based economy of Iran, where the public sector through spending of oil export revenues is the main driver of growth, management of the output gap related to the effect of the aggregate demand on inflation helps ease the unemployment–inflation trade-off in an attempt to create jobs with minimal inflationary pressure. In this context, the key for Iran’s economic stability is a sustained expansion of the productive capacity to create meaningful jobs for its growing labor force and to boost the supply of consumer and capital goods to alleviate inflationary pressures.

Some Aspects of the Evolution of Inflation-Unemployment Tradeoff

Some Aspects of the Evolution of Inflation-Unemployment Tradeoff

New Keynesian Macroeconomics: Empirically Tested in the Case of Republic of Macedonia

In this paper we test New Keynesian propositions about inflation and unemployment trade off with the New Keynesian Phillips curve and the proposition of non-neutrality of money. The main conclusion is that there is limited evidence in line with the New-Keynesian theory. Money and growth are cointegrated series and that money growth influences the economics growth with one quarter lag. Cointegration means also that if the two series are cointegrated they have long run equilibrium. St.Louis model in the paper showed overall that increase in money growth leads to decrease in the economy growth. But the effect in the equation at three quarters lag is positive. The NAIRU rate in the unemployment inflation trade off model is almost similar as high to the actual unemployment. In the New Keynesian Phillips curve not surprisingly, there appears to be no statistically significant relationship between inflation and Unemployment –even in the classical Philips curve and in adaptive expectations Philips curve by Modigliani- Papademos (1975). Or the Friedman-Phelps- Lucas expectations-augmented one between the difference of actual and expected inflation rate and the gap between actual and the natural rate of unemployment presented in the next equation.

Inflation–Unemployment Trade-off: Evidence from Bangladesh Economy

The Phillips curve is a central hypothesis in inflation dynamics which describes the relationship between unemployment and inflation. The key point of this study is to investigate the relevancy and validity of the Phillips curve hypothesis for Bangladesh over the period 1987–2009. The study attempts to evaluate two important extensions of original Phillips curve hypothesis named expectation augmented and supply shock augmented Phillips curve. Following an analytical review and using the Ordinary Least Squares technique, three models have been estimated along with specification tests, the Augmented Dickey–Fuller (ADF) unit root test and the Chow test. The data exhibits an inverse relation between inflation and unemployment in Bangladesh. The result gives an indication of the relevancy of the Phillips curve in the Bangladesh economy. The study results reveal that inflation lag, which is positively associated with inflation, strongly explains the current inflation dynamics. The other influencing factors, such as unemployment gap and change in exchange rate, are negatively correlated and change in international price of crude oil is positively correlated with inflation.

Inflation-Unemployment Trade Off: Evidence from Pakistan

High economic growth, price stability and low unemployment are the most enviable macroeconomic goals. The success of government policies is reflected in low inflation and low unemployment. The nature and costs of inflation and unemployment can have vital impact on the economy and society. Unemployment situation in Pakistan has aggravated because of rapid population growth, lacklustre economic growth, fiscal indiscipline, escalating debt-servicing and non- development expenditure which have adversely affected Pakistan economic development and poverty reduction. Import prices and fiscal indiscipline are the major causes of inflation. The empirical results show that the Phillips curve holds in Pakistan. The reduced-form Phillips curve structure reveals that the expected inflation is significant for all periods.The current unemployment exceeds the lagged unemployment which means that unemployment has been increasing at an increasing rate and this difference causes a significant change in current inflation. Lack of governance or bad governance has remained the crux of the problem. Unless foreign policy objectives are rationalised and good governance is assured, economic problems will haunt the policy- makers and the resolution of economic problems may assume pitiless façade

The economics of the Phillips curve: Formation of inflation expectations versus incorporation of inflation expectations

This paper examines the theory of the Phillips curve, focusing on the distinction between “formation” of inflation expectations and “incorporation” of inflation expectations. Phillips curve theory has largely focused on the former. Explaining the Phillips curve by reference to expectation formation keeps Phillips curve theory in the policy orbit of natural rate thinking where there is no welfare justification for higher inflation even if there is a permanent inflation–unemployment trade-off. Explaining the Phillips curve by reference to incorporation of inflation expectations breaks that orbit and provides a welfare economics rationale for Keynesian activist policies that reduce unemployment at the cost of higher inflation.

The US inflation–unemployment trade-off revisited: New evidence for policy-making

This paper addresses the various methodological issues surrounding vector autoregressions, simultaneous equations, and chain reactions, and provides new evidence on the long-run inflation–unemployment tradeoff in the US. It is argued that money growth is a superior indicator of the monetary environment than the federal funds rate and, thus, the focus is on the inflation/unemployment responses to money growth shocks. Structural vector autoregression (SVAR) and generalised method of moments (GMM) estimations confirm earlier findings in Karanassou, Sala, and Snower (2005, 2008b) obtained from chain reaction structural models: the slope of the US Phillips curve is far from vertical, even in the long-run, which implies that the nominal and real sides of the economy are symbiotic. In the light of the significant and robust long-run inflation–unemployment tradeoffs, policy makers should reconsider the classical dichotomy thesis.

Evolving Phillips Trade-Off

We characterise the evolution of the U.S. unemployment-inflation trade-off since the late XIX century era via a Bayesian time-varying parameters structural VAR. The Great Inflation episode appears as historically unique along several dimensions. In particular, the shape of the ‘Phillips loop’ - which is defined in terms of the impulse-response functions of inflation and unemployment’s deviations from equilibrium - was, during those years, clearly out of line with respect to the rest of the sample period for all structural innovations except money demand shocks. During the Great Depression, on the other hand, the Phillips trade-off did not exhibit any peculiar qualitative feature, so that, when seen through these lenses, the 1930s only stand out because of the sheer size of the macroeconomic fluctuation. The historical evolution of the Phillips trade-off exhibits virtually no connection with the evolution of the extent of trade openness of the U.S. economy. Although, by itself, this does not rule out a possible impact of globalization on the slope of the trade-off in recent years, it clearly suggests that, historically, the evolution of the trade-off has been dominated by factors other than trade openness.

NAIRU Estimates for Germany: New Evidence on the Inflation-Unemployment Trade-Off

The paper estimates the NAIRU from a Phillips curve relationship in the state-space framework. To identify the inflation-unemployment trade-off we account for a time-varying inflation trend to control for the part of inflation that is not affected by the cyclical component of unemployment. In addition we use shifts in the relative volatility of shocks to unemployment and inflation to address the simultaneity problem in Phillips curve estimations. Applying the method of Rigobon and Sack (2003) allows for a data driven identification of the contemporaneous coefficients on the unemployment gap in the Phillips curve and yields more precise estimates of the structural coefficients in the Phillips curve. This tightens the economic relation on the basis of which the NAIRU is derived.

The Inflation-Unemployment Trade-Off at Low Inflation

The Inflation-Unemployment Trade-Off at Low Inflation

The US Inflation-Unemployment Tradeoff: Methodological Issues and Further Evidence

This paper adresses the various methodological issues surrounding vector autore- gressions, simultaneous equations, and chain reactions, and provides new evidence on the long-run inflation-unemployment tradeoin the US. It is argued that money growth is a superior indicator of the monetary environment than the federal funds rate and, thus, the focus is on the inflation/unemployment responses to money growth shocks. SVAR (structural vector autoregression) and GMM (generalised method of moments) estimations confirm earlier findings in Karanassou, Sala and Snower (2005, 2008b) obtained from chain reaction structural models: the slope of the US Phillips curve is far from vertical, even in the long-run, which implies that the nominal and real sides of the economy are symbiotic. In the light of the significant and robust long- run inflation-unemployment tradeos, policy makers should reconsider the classical dichotomy thesis.

THE EVOLUTION OF INFLATION AND UNEMPLOYMENT: EXPLAINING THE ROARING NINETIES

This paper analyses the relation between US inflation and unemployment from the perspective of ‘frictional growth,’ a phenomenon arising from the interplay between growth and frictions. In particular, we focus on the interaction between money growth and nominal frictions. In this context we show that monetary policy has not only persistent, but permanent real effects, giving rise to a long‐run inflation‐unemployment tradeoff. We evaluate this tradeoff empirically and assess the impact of productivity, money growth, budget deficit, and trade deficit on the US unemployment and inflation trajectories during the nineties.

Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployement

We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation tradeoff and for the conduct of monetary policy.We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We show the role of labor market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment.We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labor market frictions and real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.

Long-run inflation-unemployment dynamics: The Spanish Phillips curve and economic policy

This paper takes a new look at the long-run dynamics of inflation and unemployment in response to permanent changes in the growth rate of the money supply. We examine the Phillips curve from the perspective of what we call “frictional growth,” i.e. the interaction between money growth and nominal frictions. After presenting a theoretical model of this phenomenon, we construct an empirical model of the Spanish economy and, in this context, we evaluate the long-run inflation-unemployment tradeoff for Spain and examine how recent policy changes have affected it.

Currency Unions, the Phillips Curve, and Stabilization Policy: Some Suggestions for Europe

This paper examines the implications of a currency union for monetary policy. The formation of a currency union worsens the inflation-unemployment trade-off, so that leaving the inflation target unchanged at its pre-currency union level generates increased unemployment. Geographically based fiscal automatic stabilizers can improve the inflation-unemployment trade-off, which has bearings on the Euro area's Stability and Growth Pact. Financial intermediary balance sheet regulation based on asset-based reserve requirements (ABRR) can provide additional country-specific policy instruments. ABRR alleviate the targets and instruments problem afflicting the monetary authority in a currency union context. This is important for the European Central Bank, which is trying to manage divergent country growth rates with a single interest rate instrument.