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Inflation and Unemployment in the Long Run

  • Aleksander Berentsen
  • Guido Menzio
  • Randall Wright

We study the long-run relation between money, measured by inflation or interest rates, and unemployment. We first discuss data, documenting a strong positive relation between the variables at low frequencies. We then develop a framework where both money and unemployment are modeled using explicit microfoundations, integrating and extending recent work in macro and monetary economics, and providing a unified theory to analyze labor and goods markets. We calibrate the model, to ask how monetary factors account quantitatively for low-frequency labor market behavior. The answer depends on two key parameters: the elasticity of money demand, which translates monetary policy to real balances and profits; and the value of leisure, which affects the transmission from profits to entry and employment. For conservative parameterizations, money accounts for some but not that much of trend unemployment -- by one measure, about 1/5 of the increase during the stagflation episode of the 70s can be explained by monetary policy alone. For less conservative but still reasonable parameters, money accounts for almost all low-frequency movement in unemployment over the last half century

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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1501.

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Length: 76 pages
Date of creation: Mar 2009
Date of revision:
Handle: RePEc:kie:kieliw:1501
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