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Relationship between inflation, unemployment and labor force change rate in France: cointegration test

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

Abstract

A linear and lagged relationship between inflation, unemployment and labor force change rate, π(t)=A0UE(t-t0)+A1dLF(t-t1)/LF(t-t1)+A2 (where A0, A1, and A2 are empirical country-specific coefficients), was found for developed economies. The relationship obtained for France is characterized by A0=-1, A1=4, A2=0.095, t0=4 years, and t1=4 years. For GDP deflator, it provides a root mean square forecasting error (RMFSE) of 1.0% at a four-year horizon for the period between 1971 and 2004. The relationship is tested for cointegration. All three variables involved in the relationship are proved to be integrated of order one. Two methods of cointegration testing are used. First is the Engle-Granger approach based on the unit root test in the residuals of linear regression, which also includes a number of specification tests. Second method is the Johansen cointegration rank test based on a VAR representation, which is also proved to be an adequate one via a set of appropriate tests. Both approaches demonstrate that the variables are cointegrated and the long-run equilibrium relation revealed in previous study holds together with statistical estimates of goodness-of-fit and RMSFE. Relationships between inflation and labor force and between unemployment and labor force are tested separately in appropriate time intervals, where the Banque de France monetary policy introduced in 1995 does not disturb the long-term links. All the individual relationships are cointegrated in corresponding intervals. The VAR and vector error correction (VEC) models are estimated and provide just a marginal improvement in RMSFE at the four-year horizon both for GDP deflator (down to 0.9%) and CPI (~1.1%) on the results obtained in the regression study. The VECM approach also allows re-estimation of the coefficients in the individual and generalized relationship between the variables both for cointegration rank 1 and 2. Comparison of the standard cointegration approach to the integral approach to the estimation of the coefficients in the individual and generalized relationships between the studied variables demonstrates the superiority of the latter. The cumulative inflation curve or inflation index, which is the actually measured evolution of price level, is much better predicted in the framework of the integral approach, which is a powerful tool for revealing true relationships between non-stationary variables and can be potentially used for rejection of spurious regression. The cumulative curves allow avoiding obvious drawbacks of the VECM representation and cointegration tests – increasing signal to noise ratio after differentiation and severe dependence on statistical properties of error terms. The confirmed validity of the linear lagged relationship between inflation, unemployment and labor force change indicates that since 1995 the Banque de France has been wrongly applying the policy fixing the monetary growth to the reference value around 4.5%. As a result of the policy, during the last ten years unemployment in France was twice as large as the one dictated by its long-term equilibrium link to labor force change. This increased unemployment compensates the forced price stability.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2736.

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Date of creation: Feb 2007
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Handle: RePEc:pra:mprapa:2736

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Keywords: cointegration; inflation; unemployment; labor force; forecasting; France; VAR; VECM;

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References

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  1. Kitov, Ivan, 2007. "Inflation, unemployment, labor force change in European countries," MPRA Paper 14557, University Library of Munich, Germany.
  2. Ivan, Kitov, 2006. "Exact prediction of inflation in the USA," MPRA Paper 2735, University Library of Munich, Germany.
  3. Ivan O. Kitov, 2005. "A model for microeconomic and macroeconomic development," Working Papers 05, ECINEQ, Society for the Study of Economic Inequality.
  4. Ivan O. Kitov, 2005. "Modelling the overall personal income distribution in the USA from 1994 to 2002," Working Papers 07, ECINEQ, Society for the Study of Economic Inequality.
  5. Ivan O. Kitov, 2006. "Inflation, unemployment, labor force change in the USA," Working Papers 28, ECINEQ, Society for the Study of Economic Inequality.
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Cited by:
  1. Kitov, Ivan, 2007. "Exact prediction of inflation and unemployment in Japan," MPRA Paper 5464, University Library of Munich, Germany.
  2. Kitov, Ivan, 2007. "Exact prediction of inflation and unemployment in Germany," MPRA Paper 5088, University Library of Munich, Germany.
  3. Kitov, Ivan, 2009. "The anti-Phillips curve," MPRA Paper 13641, University Library of Munich, Germany.
  4. Ivan O. Kitov & Oleg I. Kitov, 2008. "Long-Term Linear Trends In Consumer Price Indices," Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 3(2(4)_Summ).
  5. Kitov, Ivan & Kitov, Oleg & Dolinskaya, Svetlana, 2008. "Comprehensive macro-model for the U.S. economy," MPRA Paper 9808, University Library of Munich, Germany.

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