Inflation and Unemployment in Germany

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Exact prediction of inflation and unemployment in Germany
Ivan O. Kitov

Abstract
Potential links between inflation, π(t), and unemployment, UE(t), in Germany have been examined. There exists a consistent (conventional) Phillips curve despite some changes in monetary policy. This Phillips curve is characterized by a negative relation between inflation and unemployment with the latter leading the former by one year: UE(t-1) = -1.50π(t) + 0.116. Effectively, growing unemployment has resulted in decreasing inflation since 1971, i.e. for the period where GDP deflator observations are available. The relation between inflation and unemployment is statistically reliable with R2=0.86, where unemployment spans the range from 0.01 to 0.12 and inflation, as represented by GDP deflator, varies from -0.01 to 0.07. A linear and lagged relationship between inflation, unemployment and labor force has been also obtained for Germany. Changes in labor force level are leading unemployment and inflation by five and six year, respectively. Therefore this generalized relationship provides a natural prediction of inflation at a sixyear horizon, as based upon current estimates of labor force level. The goodness-of-fit for the relationship is 0.87 for the period between 1971 and 2006, i.e. including the periods of high inflation and disinflation. Key words: inflation, unemployment, labor force, prediction, Germany JEL Classification: E3, E6, J21

Introduction
This paper is a continuation of a series devoted to the change rate of labor force level as the driving force behind inflation and unemployment (Kitov, 2006abc; Kitov, 2007ab; Kitov, Kitov, Dolinskaya, 2007ab). The principal finding of our previous studies conducted for the USA, Japan, France, Austria and Canada consists in the existence of a linear and lagged link between labor force, inflation and unemployment. In some countries, this generalized link can be separated into two independent linear links between inflation and labor force and between unemployment and labor force. These linear dependencies on one variable, obviously, result in the existence of reliable Phillips curves in these countries. These Phillips curves are not of conventional form, however, since they are represented by lagged dependences between inflation and unemployment. It is important that coefficients (tangents) in these linear dependencies can be positive and negative. In the former case (positive tangent), increasing inflation is associated with increasing (but lagged) unemployment, as is it observed in the USA (Kitov, 2006ab). In

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the latter case, increasing inflation results in a decreasing unemployment rate, as observed in Germany (Kitov, 2007b).
Data on labor force, inflation, and unemployment were obtained from various sources. There are three principal statistical agencies providing these data: the OECD, the Eurostat, and the U.S. Bureau of Labor Statistics (BLS). The BLS provides two sets of data: one obtained according to national definition (NAC) and another obtained according to US definition of corresponding variable.

For any quantitative analysis, the most important issue is the quality of corresponding measurements. There are two main requirements to these data: they have to be as precise as possible according to any given definition, and the data must by comparable over time. The precision is related to methodology of measurements and implementation of corresponding procedures.

The comparability is provided by the

consistency of definitions and methodology. For example, the OECD (2005).provides the following information on the comparability of the labor force and unemployment time series for Germany
Series breaks: From 1999, the data have been calculated using an improved method of calculation and only refer to private households (Eurostat definition). Previously, persons living in collective and institutional accommodation, conscripts on compulsory community or military service...
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