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Inflation as a function of labor force change rate: cointegration test for the USA

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  • Kitov, Ivan
  • Kitov, Oleg
  • Dolinskaya, Svetlana

Abstract

Previously, a linear and lagged relationship between inflation and labor force change rate, π(t)= A1dLF(t-t1)/LF(t-t1)+A2 (where A1 and A2 are empirical country-specific coefficients), was found for developed economies. The relationship obtained for the USA is characterized by A1=4.0, A2=-0.03075, and t1=2 years. It provides a root mean square forecasting error (RMFSE) of 0.8% at a two-year horizon for the period between 1965 and 2002 (the best among other inflation forecasting models) and has a perfect parsimony - only one predictor. The relationship is tested for cointegration. Both variables are integrated of order one according to the presence of a unit root in the series and its absence in their first differences. Two methods of cointegration testing are applied - the Engle-Granger one based on the unit root test of the residuals including a variety of specification tests and the Johansen cointegration rank test based on the VAR representation. Both approaches demonstrate that the variables are cointegrated and the long-run equilibrium relation revealed in previous study holds. According to the Granger causality test, the labor force change is proved to be a weakly exogenous variable - a natural result considering the time lead and the existence of a cointegrating relation. VAR and VECM representations do not provide any significant improvement in RMSFE. There are numerous applications of the equation: from purely theoretical - a robust fundamental relation between macroeconomic and population variables, to a practical one - an accurate out-of-sample inflation forecasting at a two-year horizon and a long-term prediction based on labor force projections. The predictive power of the relationship is inversely proportional to the uncertainty of labor force estimates. Therefore, future inflation research programs should start from a significant improvement in the accuracy of labor force estimations

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2734.

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Date of creation: Jan 2007
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Handle: RePEc:pra:mprapa:2734

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Keywords: cointegration; inflation; labor force; forecasting; USA; VAR; VECM;

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  1. Kitov, Ivan, 2007. "Inflation, unemployment, labor force change in European countries," MPRA Paper 14557, University Library of Munich, Germany.
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Cited by:
  1. Kitov, Ivan, 2007. "Exact prediction of inflation and unemployment in Canada," MPRA Paper 5015, University Library of Munich, Germany.
  2. Kitov, Ivan, 2009. "Predicting gold ores price," MPRA Paper 15873, University Library of Munich, Germany.
  3. Kitov, Ivan & Kitov, Oleg, 2009. "PPI of durable and nondurable goods: 1985-2016," MPRA Paper 15874, University Library of Munich, Germany.
  4. Kitov, Ivan & Kitov, Oleg, 2011. "The Australian Phillips curve and more," MPRA Paper 28762, University Library of Munich, Germany.
  5. Kitov, Ivan & Kitov, Oleg & Dolinskaya, Svetlana, 2008. "Comprehensive macro-model for the U.S. economy," MPRA Paper 9808, University Library of Munich, Germany.
  6. Kitov, Oleg & Kitov, Ivan, 2011. "Inflation and unemployment in Switzerland: from 1970 to 2050," MPRA Paper 28887, University Library of Munich, Germany.
  7. Kitov, Oleg & Kitov, Ivan, 2011. "A win-win monetary policy in Canada," MPRA Paper 29975, University Library of Munich, Germany.
  8. Kitov, Ivan, 2009. "Predicting the price index for jewelry and jewelry products: 2009 to 2016," MPRA Paper 15875, University Library of Munich, Germany.
  9. Kitov, Ivan, 2007. "Exact prediction of inflation and unemployment in Japan," MPRA Paper 5464, University Library of Munich, Germany.
  10. Kitov, Ivan, 2007. "Exact prediction of inflation and unemployment in Germany," MPRA Paper 5088, University Library of Munich, Germany.
  11. Kitov, Ivan, 2009. "The anti-Phillips curve," MPRA Paper 13641, University Library of Munich, Germany.
  12. Kitov, Ivan & Kitov, Oleg, 2009. "A fair price for motor fuel in the United States," MPRA Paper 15039, University Library of Munich, Germany.

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