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Do we know how low inflation should be?

The paper looks for evidence of grease and sand effects in Europe, in particular the possibility that the natural rate of unemployment is affected run by the inflation rate. Looking at four countries, France, Germany, the Netherlands and Switzerland, the paper reports some preliminary evidence that the long-run rate of unemployment is a nonlinear function of inflation. The particular shape of the empirical relationship supports the view that a moderate level of inflation provides some "grease" to the price and wage setting process. In particular, the long-run rate of unemployment is found to reach a maximum between 0.5% and 1%, and to quickly decline for higher rate of inflation. For the range of inflation rates observed in the sample countries, there is no evidence of sand effects, that uncertainty associated with inflation adversely affect the long-run rate of unemployment.

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File URL: http://repec.graduateinstitute.ch/pdfs/Working_papers/HEIWP06-2001.pdf
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Paper provided by Economics Section, The Graduate Institute of International Studies in its series IHEID Working Papers with number 06-2001.

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Length: 33 pages
Date of creation: 11 Jan 2001
Date of revision:
Handle: RePEc:gii:giihei:heiwp06-2001
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  1. Robert J. Gordon, 1998. "Foundations of the Goldilocks Economy: Supply Shocks and the Time-Varying NAIRU," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 297-346.
  2. David Gruen & Adrian Pagan & Christopher Thompson, 1999. "The Phillips Curve in Australia," RBA Research Discussion Papers rdp1999-01, Reserve Bank of Australia.
  3. Caprio,Gerard & Honohan,Patrick & Stiglitz,Joseph E. (ed.), 2001. "Financial Liberalization," Cambridge Books, Cambridge University Press, number 9780521803694.
  4. 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.
  5. Erica L. Groshen & Mark E. Schweitzer, 1997. "Identifying Inflation's Grease and Sand Effects in the Labor Market," NBER Working Papers 6061, National Bureau of Economic Research, Inc.
  6. Lars E. O. Svensson, 1996. "Price Level Targeting vs. Inflation Targeting: A Free Lunch?," NBER Working Papers 5719, National Bureau of Economic Research, Inc.
  7. Guy Debelle & James Vickery, 1997. "Is the Phillips Curve a Curve? Some Evidence and Implications for Australia," RBA Research Discussion Papers rdp9706, Reserve Bank of Australia.
  8. David Card & Dean Hyslop, 1997. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122 National Bureau of Economic Research, Inc.
  9. Stanley Fischer, 1996. "Why are central banks pursuing long-run price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 7-34.
  10. Olivier Blanchard & Justin Wolfers, 1999. "The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence," NBER Working Papers 7282, National Bureau of Economic Research, Inc.
  11. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173, March.
  12. Holden, Steinar, 1994. "Wage bargaining and nominal rigidities," European Economic Review, Elsevier, vol. 38(5), pages 1021-1039, May.
  13. Olivier Blanchard & Lawrence F. Katz, 1996. "What We Know and Do Not Know About the Natural Rate of Unemployment," NBER Working Papers 5822, National Bureau of Economic Research, Inc.
  14. Edmund Phelps & Gylfi Zoega, 2001. "Structural booms," Economic Policy, CEPR;CES;MSH, vol. 16(32), pages 83-126, 04.
  15. Wyplosz, Charles, 1999. "Financial Restraints and Liberalization in Postwar Europe," CEPR Discussion Papers 2253, C.E.P.R. Discussion Papers.
  16. Michael Bruno & William Easterly, 1996. "Inflation and growth: in search of a stable relationship," Review, Federal Reserve Bank of St. Louis, issue May, pages 139-146.
  17. Robert J. Barro & Paul Romer, 1993. "Economic Growth," NBER Books, National Bureau of Economic Research, Inc, number barr93-1.
    • Robert J. Barro & Paul M. Romer, 1991. "Economic Growth," NBER Books, National Bureau of Economic Research, Inc, number barr91-1.
  18. Michael Bruno & William Easterly, 1996. "Inflation and growth: in search of a stable relationship," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 139-146.
  19. 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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