Do interest rate and inflation affect unemployment? evidence from Australia

This paper explores the Granger-causal relationship between monetary policy, represented by interest rate and inflation rate, and the unemployment rate in Australia using the standard time series techniques. The analysis uses quarterly data covering a ten-year period. Interest rates used here is the long term interest rate, inflation rate is represented by the CPI excluding food and energy, and unemployment rates is measured in percentage-form for Australia. The findings evidence a positive long term (theoretical) relationship between interest rate and unemployment, and a negative long term relationship between inflation and unemployment. It also suggests that interest rate is the strongest exogenous variable, followed by the inflation rate, in determining unemployment. As such, it is recommended for the policy makers of small open economies such as, Australia to control the exogenous variables in order to achieve a certain desired target of unemployment rate. Or, should these two relatively exogenous variables be to some extent “uncontrollable” due to factors such as, crisis and calamity, their movements could be reliable indicators for the governments to embark on contingency plans to minimize the impact of unemployment.