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Low-Inflation Targeting and Unemployment Persistence

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  • Lundborg, Per

    (Trade Union Institute for Economic Research)

  • Sacklén, Hans

    (Trade Union Institute for Economic Research)

Abstract

A recent model by Akerlof, Dickens and Perry (2000) (ADP) predicts that low inflation may cause unemployment to persist at high levels. This finding should be of major interest to European countries where inflation is targeted at low levels. We specify a small open economy version of the ADP model and apply it to Swedish data. The results indicate that raising the Swedish inflation target from 2 to 4% would bring long-run unemployment down by two percentage points, to 2.0-2.5%. EMU membership, with inflation at the average of the present 0-2% band, would raise unemployment to around 6%. Membership thus implies a rejection of a national inflation target that could maximize employment. Given that long run unemployment-inflation trade-offs can be found in other countries as well, there is nothing to suggest that these trade-offs are identical across countries. A single inflation rate in the EMU may then cause unemployment to widely exceed the lowest sustainable rate in individual countries. We also extend the ADP model by showing theoretically that the unemployment minimizing inflation rate could lead to too low output. However, empirically we find, both for Sweden and the U.S., that minimum unemployment and maximum output occur at roughly the same rate of inflation.

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Bibliographic Info

Paper provided by Trade Union Institute for Economic Research in its series Working Paper Series with number 188.

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Length: 34 pages
Date of creation: 07 May 2003
Date of revision:
Handle: RePEc:hhs:fiefwp:0188

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Keywords: Phillips curve; Efficiency wages; Near-rationality;

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References

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  1. Karanassou, Marika & Sala, Hector & Snower, Dennis J., 2002. "A Reappraisal of the Inflation-Unemployment Tradeoff," IZA Discussion Papers 636, Institute for the Study of Labor (IZA).
  2. Steinar Holden, 2001. "Monetary Policy and Nominal Rigidities under Low Inflation," CESifo Working Paper Series 481, CESifo Group Munich.
  3. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678.
  4. Ray C. Fair, 2000. "Testing the NAIRU Model for the United States," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 64-71, February.
  5. King, Robert G. & Watson, Mark W., 1994. "The post-war U.S. phillips curve: a revisionist econometric history," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 41(1), pages 157-219, December.
  6. Chen, P. & Edin, P.A., 1996. "Efficiency Wages and Industry Wages Differentials : A Comparison Across Methods of Pay," Papers 314, Australian National University - Department of Economics.
  7. Agell, Jonas & Lundborg, Per, 1995. " Theories of Pay and Unemployment: Survey Evidence from Swedish Manufacturing Firms," Scandinavian Journal of Economics, Wiley Blackwell, vol. 97(2), pages 295-307, June.
  8. Bullard, James & Keating, John W., 1995. "The long-run relationship between inflation and output in postwar economies," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 477-496, December.
  9. George A. Akerlof & William T. Dickens & George L. Perry, 2000. "Near-Rational Wage and Price Setting and the Long-Run Phillips Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(1), pages 1-60.
  10. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
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Cited by:
  1. Selén, Jan & Ståhlberg, Ann-Charlotte, 2004. "Wage and Compensation Inequality — How Different?," Working Paper Series 197, Trade Union Institute for Economic Research.
  2. Lundborg, Per, 2008. "Wage Redistribution and the Long Run Phillips Curve," Working Paper Series 3/2008, Swedish Institute for Social Research.
  3. Bryan, Michael F. & Palmqvist, Stefan, 2005. "Testing Near-Rationality using Detailed Survey Data," Working Paper Series 183, Sveriges Riksbank (Central Bank of Sweden).
  4. Stefan Palmqvist & Michael F. Bryan, 2005. "Testing Near-Rationality Using Detail Survey Data," Computing in Economics and Finance 2005 371, Society for Computational Economics.
  5. Michael F. Bryan & Stefan Palmqvist, 2005. "Testing near-rationality using detailed survey data," Working Paper 0502, Federal Reserve Bank of Cleveland.
  6. Abdul Aleem & Amine Lahiani, 2011. "Estimation and evaluation of core inflation measures," Applied Economics, Taylor & Francis Journals, vol. 43(25), pages 3619-3629.
  7. Lundborg, Per, 2005. "Wage Fairness, Growth and the Utilization of R&D Workers," Working Paper Series 206, Trade Union Institute for Economic Research.

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