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Low-Inflation Targeting and Unemployment Persistence

Author

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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.

Suggested Citation

  • Lundborg, Per & Sacklén, Hans, 2003. "Low-Inflation Targeting and Unemployment Persistence," Working Paper Series 188, Trade Union Institute for Economic Research.
  • Handle: RePEc:hhs:fiefwp:0188
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    File URL: http://swopec.hhs.se/fiefwp/papers/WP188.pdf
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    References listed on IDEAS

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    1. 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.
    2. Paul Chen & Per-Anders Edin, 2002. "Efficiency Wages and Industry Wage Differentials: A Comparison Across Methods of Pay," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 617-631, November.
    3. 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.
    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. 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.
    6. Karanassou, Marika & Sala, Hector & Snower, Dennis J., 2005. "A reappraisal of the inflation-unemployment tradeoff," European Journal of Political Economy, Elsevier, vol. 21(1), pages 1-32, March.
    7. 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.
    8. Holden,S., 2001. "Monetary policy and nominal rigidities under low inflation," Memorandum 16/2001, Oslo University, Department of Economics.
    9. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678-678.
    10. 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.
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    Citations

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    Cited by:

    1. Michael F. Bryan & Stefan Palmqvist, 2005. "Testing near-rationality using detailed survey data," Working Paper 0502, Federal Reserve Bank of Cleveland.
    2. Lundborg, Per, 2005. "Wage Fairness, Growth and the Utilization of R&D Workers," Working Paper Series 206, Trade Union Institute for Economic Research.
    3. Novella Maugeri, 2010. "Macroeconomic Implications of Near Rational Behavior: an Application to the Italian Phillips Curve," Department of Economics University of Siena 587, Department of Economics, University of Siena.
    4. Selén, Jan & Ståhlberg, Ann-Charlotte, 2004. "Wage and Compensation Inequality — How Different?," Working Paper Series 197, Trade Union Institute for Economic Research.
    5. Bryan, Michael F. & Palmqvist, Stefan, 2005. "Testing Near-Rationality using Detailed Survey Data," Working Paper Series 183, Sveriges Riksbank (Central Bank of Sweden).
    6. Lundborg, Per, 2008. "Wage Redistribution and the Long Run Phillips Curve," Working Paper Series 3/2008, Stockholm University, Swedish Institute for Social Research.
    7. Stefan Palmqvist & Michael F. Bryan, 2005. "Testing Near-Rationality Using Detail Survey Data," Computing in Economics and Finance 2005 371, Society for Computational Economics.
    8. Abdul Aleem & Amine Lahiani, 2011. "Estimation and evaluation of core inflation measures," Applied Economics, Taylor & Francis Journals, vol. 43(25), pages 3619-3629.

    More about this item

    Keywords

    Phillips curve; Efficiency wages; Near-rationality;

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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