The relationship between dynamic price and dynamic unemployment: the case of the Central European-3 and the Baltic Tigers

Transcription

1 The relaionship beween dynamic price and dynamic unemploymen: he case of he Cenral European-3 and he Balic Tigers Luis F. Dumlao ABSTRACT Convenion specifies he relaionship beween price and unemploymen in erms of he Phillips curve (PC) where inflaion and he rae of unemploymen are correlaed. This paper uses a varian of he PC ha is more consisen wih he relaionship beween price and oupu as depiced in he aggregae supply (AS) curve. The relaionship beween price and unemploymen using convenion and is varian is esed on Poland, he Czech Republic, Hungary, Esonia, Lavia, Lihuania and he pooled daa. The Expecaions Augmened (EA) is able o rack a negaive relaion beween inflaion and unemploymen beer han he New Keynesian (NK) is able. Wihin he EA runs, he convenion is able o rack he same negaive relaion beer han he varian, bu one has o be cauious given he implied resuls. Keywords: Employmen, Unemploymen, Inflaion, Incomes Policy, Price Policy, Phillips Curve, Cenral Europe, Balic Tigers. JEL Classificaion codes: E24, E31, E64 Auhor Luis F. Dumlao. Deparmen of Economics, School of Social Sciences, Aeneo de Manila Universiy, Mero Manila, Philippines. ldumlao@aeneo.edu. Ciaion Luis F. Dumlao (2014). The relaionship beween dynamic price and dynamic unemploymen: he case of he Cenral European-3 and he Balic Tigers. Inernaional Journal of Economic Sciences, Vol. III, No. 2/2014, pp

2 Inroducion Convenion specifies he relaionship beween price and unemploymen in erms of he Phillips curve (PC) where inflaion and he rae of unemploymen are believed o be negaively correlaed. However, he relaionship is ambiguous when juxaposed wih he relaionship beween price and oupu as depiced in he aggregae supply (AS) curve (Dumlao, 2012). In he AS curve, price and oupu are boh expressed in erms of heir saic levels. Bu in he PC, price is expressed in is dynamic sae and unemploymen is expressed in is saic sae. Tha is, inflaion or he rae of change of price hrough ime is correlaed wih he rae of unemploymen ha is capured a a cerain ime. A varian specificaion is where inflaion is relaed wih he rae of change of unemploymen and employmen. As such, he relaionship beween price and unemploymen has sronger heoreical basis in he conex ha i is direcly derived from he AS curve. This paper ess if here is a relaionship beween price and unemploymen using he convenional specificaion and he varian. The es covers he Cenral European economies Poland, he Czech Republic and Hungary or he CE-3 and Esonia, Lavia and Lihuania or he Balic Tigers. The res of he paper is organized as follows. The firs secion is a review of lieraure. The second secion is a heoreical derivaion of he varian specificaion from he AS curve and Roemberg s (1982) quadraic price adjusmen cos model. The hird, fourh and fifh secions presen he empirical models of he PCs, he daa used and he resuls respecively. The sixh is conclusion. 1. Review of Lieraure Going back o The General Theory of Employmen, Ineres and Money, Keynes (1936) describes he AS curve as one ha is posiively sloped and ha he slope is a an increasing rae. Figure 1 shows he AS curve shown in mainsream exbooks like ha in Dornbusch, Fischer and Sarz (2001, page 89). In 1958, Phillips found and published he empirical relaionship beween he rae of change of wage wih he rae of unemploymen in he Unied Kingdom from 1861 o Such relaion became known as he wage Phillips curve (WPC) depiced in Figure 2. As wage level is pegged wih he price level, he rae of change of wage mus move wih he rae of change of price or inflaion. Hence, subsiuing inflaion for he rae of change of wage resuls in Figure 3, ha is generally referred in lieraure as he Phillips curve (PC). As in Sleeman (2011), Samuelson and Solow in 1960 chrisened he Phillips curve and inerpreed i as a poenial radeoff beween inflaion and unemploymen (page 235). However, evidence from Phillips original daa (Lipsey, 1960) and evidence from he Unied Saes esed in he 1960s proves ha he relaionship beween inflaion and unemploymen rae is no convincingly consisen wih ha depiced in Figures 2 and 3 respecively. Such ess imply ha here was no one sable PC. Raher, here seems o be many PCs ha shif over ime as resul of some no ye deermined facor. In 1968, Friedman esablished ha expecaions in inflaion cause shifs of he PC hus he expecaions augmened PC (EAPC). Where and e are acual and expeced inflaions respecively, u and 21

3 u N are raes of acual and some naural unemploymen, and a is some posiive parameer; Friedman and Phelps EAPC is convenionally expressed as: e N 1. a( u u ). Figure 1 - Aggregae Supply (AS) Curve Figure 2 - Wage Phillips Curve (WPC) P AS w/w Y u Figure 3 - Phillips Curve (PC) A differen inerpreaion is ha of he New Keynesians following Roemberg s (1982) quadraic price adjusmen cos model, and Calvo s (1983) and Taylor s (1979) saggered conracs model. Where y is log of oupu and y N is log of he naural oupu, Robers (1995) synhesizes he models o 1 N 2. E 1 a( y y ). u As in Robers and Blanchard and Gali (2007), he above is commonly referred o as he New Keynesian Phillips Curve (NKPC). Accordingly, inflaion is a funcion of expeced fuure inflaion (E +1 ) and no he expeced curren inflaion ( e ). Noice he way ha expecaion is expressed. For a given variable like, E -1 is he expeced inflaion as of period -1, e is he expeced inflaion as of presen ex ane he acual inflaion is calculaed and published, and (wihou he superscrip e) is he acual inflaion ha is known ex pos i is calculaed and published. 1 The more general noaion is p = c + E p +1 + y +, where p is he log of price level, y is he oupu gap, c and are posiive coefficiens and is he error erm. The noaion is adjused for consisency wih he res of he ex. The sochasic error erm e is also excluded for convenience wihou loss of generaliy. 22

4 In his framework, prices are sicky because of some lack of fluidiy in he micro level like cos of adjusmen and firms changing prices on a saggered basis. Taylor (1979) and he Keynesians in general view he labor markes as cenral o aggregae nominal rigidiies. As such, unemploymen is viewed as an alernaive someimes even superior indicaor of overall economic aciviy. The pracice is o subsiue unemploymen rae for he oupu gap. Wha follows is wha his paper will refer o as he NKPC: N 3. E 1 a( u u ). Convenion presumes ha he relaionship beween price and oupu conveyed in he AS curve (Figure 1) ranslaes o he relaionship beween inflaion and unemploymen conveyed in he PC (Figure 3).The convenional presumpion seems sraighforwardly logical. Firs, higher inflaion resuls in higher price level so ha i should follow ha he verical axes in boh have consisen relaionship eiher wih oupu or wih unemploymen. Second, higher oupu resuls in higher employmen so ha subsiuing unemploymen rae for oupu should inver o he curve as i appears going from he AS curve o he PC. Bu Dumlao (2012) argues ha he convenion s presumpion from one verical axis o anoher and one horizonal axis o anoher is ambiguous. Accordingly, on he verical axis, high price level a presen resuled from high inflaion in he pas bu i does no necessarily mean ha inflaion is high a presen. Hence a high price a presen may coincide wih a low inflaion a presen. On he horizonal axis, any level of oupu does no necessarily ranslae o some rae of unemploymen. All else being equal, higher levels of oupu require higher levels of employmen. However, he sory on he level of employmen is disinc from he sory of he rae of employmen. More so, higher levels of employmen resul in higher raes of employmen only if he increase in he level of employmen is greaer han he increase in he oal labor force. Also, he reamen of variables in he AS curve is no consisen wih ha in he PC. In he AS, boh price and oupu are expressed in levels wihou some reference o some oal price and some oal oupu. In he PC, price expressed in inflaion is sill wihou reference o some oal inflaion bu suddenly he supposed opposie of oupu which is unemploymen is in reference o some absolue range from zero o 100 percen. More imporanly, he inverse relaionship beween inflaion and unemploymen rae as shown in he PC is no always rue. For example, If 3 of 100 people are unemployed and hey have no ousanding job offers for some ime, hey will no as much demand for higher wages so ha here will be less wage inflaion. Likewise, if employers are saisfied wih heir workforce such ha here is hiring freeze, hey will no aggressively look for applicans so as o increase heir offer wage and his will cause less wage inflaion. If 10 of 100 people are unemployed and have 15 ousanding job offers, hey will likely ask prospecive employers o bid so as o drive wages higher hus causing wage inflaion. Likewise, if employers are aggressively expanding and seeking for addiional workers, hey will as aggressively increase heir offer wage hus causing wage inflaion. 23

5 Therefore, a lower rae of unemploymen can correspond o low inflaion and a higher rae of unemploymen can correspond o higher inflaion. 2. Theoreical Derivaion of Varian EAPC and Varian NKPC a. Aggregae Supply Curve As in Dumlao (2012), assume ha he saic level of wage is relaed wih he saic level of expeced price and saic level of unemploymen. Where P is he price level, U is he saic level (as opposed o rae) of unemploymen and T is populaion of labor force, he relaionship may be saed in e P 4. W. U / T Noe ha all variables are expressed in saic levels and ha all are expressed no in comparison o some benchmark limi; ha is here is no oals in wage, price, unemploymen and labor force. Assume for simplificaion ha here is only one inpu and ha is labor. Where Y j and L j are oupu and labor employmen of firm j, A is echnological parameer and is labor elasiciy, consider he ypical producion funcion 5. Y AL, 0 1. j j Assume perfec compeiion. Where P i and W i are price and wage levels in indusry i, profi is 6. PY W L P AL W L. i j i j i j i j The represenaive firm canno affec wage and price bu can affec he number of laborers i employs. As such, i is lef ou in choosing he opimal number of laborers which resuls in he profi maximizing soluion which is: 7. Y PAL W P W. 1 j i j i i i Lj Consisen wih general pracice in Neoclassical and New Keynesian (NK) lieraure, i is inferred ha wha happens a he macro level mimics wha happens in he micro level. Hence, he macroeconomic oucome is Y 8. P W. L Combining equaion 4 wih he above and hen solving for price gives 9. 1 e T L P P. Y U 24

6 The above is his paper s AS curve. Consisen wih he sandard AS properies as in Figure 1, an increase in expeced price raises he price (upward shif of he AS curve). An increase in he labor force (T) wih proporionae increase in L and U while keeping he price level consan necessarily means an increase of level of oupu (Y) (righward shif of he AS). An increase in echnology (A) increases oupu (Y) and lowers he price (downward shif of he AS curve). An increase in employmen (L) ha in urn decreases unemploymen (U) increases he price (movemen along he AS curve). b. Roemberg s quadraic price adjusmen cos model Similar resuls come ou if one uses eiher ha of Roemberg (1982), Calvo (1983) or Taylor (1979). They all lead o he same basic NKPC as Robers (1995) shows. This paper arbirarily picks ha of Roemberg s. In his framework, firms minimize he cos of seing price from some ideal price and he cos of changing price. Suppose ha C is cos, P is he acual price and P C is he ideal price bu wih cos o adjusmen, and heir lower case being heir respecive naural logs. The quadraic price adjusmen funcion is 10. C c E ( p p ) ( p p ). Because here is cos o adjusing prices, he firm is forced o charge a a price of p insead of p C, so ha p -p C is he cos of he price being differen from some ideal price. On he oher hand, p -p -1 is he cos of adjusing he price. The usual formulaion includes a discoun facor such as ha used by Robers; for simplificaion wihou losing generaliy, he facor is excluded here. Where P M is he average price of he res of he marke or he firm s compeiors and Y N is he rended oupu, similar o Robers, i is specified ha 11. C M N p p ( y y ). The above saes ha he ideal price wih cos o adjusmen is pegged along he same level as he res of compeiion. In addiion, if aggregae demand increases, oupu expands over is rended level and so he ideal price increases. Assume ha all firms are idenical as Robers does. Wih p being he choice variable, i can be shown ha N E 1 1 dp dy 12., &. 2 2 d d c. Varian of he EAPC and NKPC Refer back o he AS curve in equaion 9. Taking he log of each side and hen aking he ime derivaive yield e U L T 13. ( ) ( ),, &. U L T 25

7 If here is price adjusmen cos, equaion 12 is incorporaed in equaion 13 hrough he variable. Furher rearranging gives 14. e N 2 E If one assumes adapive expecaions, pas inflaion can subsiue for expeced inflaion. Bu his canno be sricly applied in he NK seing. The reason is ha e implicily depends on E +1 where he curren informaion se includes prices caching up o arge prices. In Roemberg s framework, he arge price is he price had here been no cos of adjusmen. In Calvo s framework, i is he price signaled in he mids of saggered price adjusmens. And in Taylor s framework, i is a funcion of wage, wage is a funcion of conraced wages, and a conraced wage is a funcion of real wages over he life (oday up o he fuure expiraion) of a conrac. Anoher reason as Rudd and Whelan (2005) would argue is ha subsiuing -1 for e ignores ineria. An alernaive and a purely NK approach is o proxy E +1 for e bu Fuhrer (1997) suggess ha he pure forward looking specificaion of prices is empirically unimporan (Daniskova and Fidrmuc, 2011, page 101). Assume ha e depends on pas inflaion and he expeced fuure inflaion, i may be specified ha e E Insering he above ino equaion 14 and hen simplifying gives E N 16. ( ) ( ) Looking a equaions 13 and 16, he inuiive and empirical relaionship beween and - is ambiguous. Suppose ha oupu acceleraes and ha he labor force grows consanly or is consan. In he case of acceleraion coming from produciviy, inflaion will be lower; bu in he case of acceleraion coming from employmen, inflaion will be higher. This ambiguiy is paricularly relevan wih economies wih sable populaion growh. For simplificaion wihou loss of he main issue of ineres, equaions 13 and 16 are expressed as e 17. a( ). 18. E 1 1 a( ). 2 The above are varians of he convenional specificaions EAPC and NKPC expressed in equaions 1 and 3. This paper from his poin refers o hese as EAPC-2 and NKPC-2. Noe he difference. Inflaion is relaed wih unemploymen rae in EAPC and NKPC whereas inflaion is relaed wih he growh rae of unemploymen ne of he growh rae of employmen in EAPC-2 and NKPC-2. Borrowing from Blanchard and Kaz (1997, page 53), Wha maers o he unemployed is no how many of hem here are, bu how many of hem 26

8 here are in relaion o he number of hires by firms. In addiion, price is expressed in is dynamic sae and unemploymen in he saic sae in EAPC and NKPC. However, price and unemploymen are boh expressed in heir dynamic saes in he case of EAPC-2 and NKPC Empirical Models of EAPC, NKPC, EAPC-2 and NKPC-2 The sochasic equaions for he EAPC, NKPC, EAPC-2 and NKPC-2 are 19. b c 1 au d Counry ecrisis f, 20. b c 1 au d Counry ecrisis f, 21. b c 1 a( ) d Counry e Crisis f & 1 1 b c a( ) d Counry e Crisis f The noaions a, b, c, d and e are parial regression coefficiens, and f is he error erm assumed o be serially uncorrelaed. As in sandard assumpion of adapive expecaion as in Ball (2000) and Ball and Mankiw (2002), pas inflaion or -1 proxies for e whenever applicable. As in McCallum (1976) or as in Gali and Gerler s (1999) assumpion of raional expecaions, he acual fuure inflaion can proxy for he expeced fuure inflaion so ha +1 proxies for E +1 whenever applicable. The noaion [Counry] is a vecor of fixed effec variables represening Hungary, he Czech Republic, Lavia, Lihuania or Esonia. If all fixed effec variables have value of zero, he counry is Poland. 4. This paper concenraes on Poland, Hungary and he Czech Republic or he CE-3, and Esonia, Lavia and Lihuania or he Balic Tigers. The lumping of hese economies is convenien. The firs reason of convenience is geography. All are locaed in norh and cenral Europe. Each is adjacen o a leas one oher. And four of six coas along he Balic Sea. The second reason is shared hisory. All were common saellies of he former Sovie Union. All seceded from he Sovie rule and communism in Specifically, he Balic Tigers seceded from a single revoluion known as he Singing Revoluion. In 1999, each of he CE-3 simulaneously joined he Norh Alliance Treay Organizaion. In he European Union, Poland and Hungary applied for membership in 1994, he Balic Tigers in 1995, and he Czech Republic in I is concomian ha he hird reason is economics. In he early 1990 s each is classified as a Transiion Economy. Each has is own currency and herefore moneary policy in he coverage of he sudy; ha is from as early as 1998 o Each fulfilled he economic precondiions of joining he European Union in abou he same ime as each became full member in The levels of per capia income are close o each oher. For example, I access he IMF (2011) and here are 182 counries whose daa on GDP per capia from 1998 o 2008 (or par of he said years) is available. Ranking hem from highes o lowes, i can be shown ha The Czech Republic is 43 rd, Hungary is 46 h, Esonia is 47 h, Poland is 52 nd, Lihuania is 53 rd and Lavia is 55 h. 27

9 The daa for he levels of price, unemploymen and employmen are aken from he Inernaional Labor Organizaion downloadable from laborsa.ilo.org. All raw daa are annual. All employmen and unemploymen daa are gahered from he Labor Force Survey. Inflaion rae, unemploymen rae, and he raes of change of unemploymen and employmen are hen calculaed from he downloaded numbers. All economies involved wen hrough ransiion from communism o capialism, and so i is undersandable ha all did no have he characerisics of a normal capialisic economy immediaely afer Table 1 summarizes he coverage of he daa. Accordingly, he firs year ha all growh raes are calculable for Hungary is 1993 wih 22 percen inflaion, for Esonia is 1992 wih 1,060 percen inflaion, for Lavia is 1992 wih 957 percen inflaion, and for Lihuania is 1995 wih 40 percen inflaion. The coverage of daa esing begins when he economies become normal capialisic economies and he assumpion is ha his begins when inflaion reach 10 percen or less for he firs ime. Table 1 Summary of Coverage of Poland Czech R. Hungary Esonia Lavia Lihuania Firs employmen daa Las employmen daa Firs CPI daa Las CPI daa Firs complee raes 1999 (7%) 1994 (10%) 1993 (22%) 1992 (1,060%) 1992 (957%) 1995 (40%) Firs =<10% inflaion 1999 (7%) 1994 (10%) 2000 (10%) 1998 (8%) 1997 (8%) 1997 (9%) Observaions in EAPC Observaions in NKPC Financial Crisis 1997, Source of levels of employmen and consumer price index: ILO In he case of Poland, he firs year when he daa on levels is complee is The firs period ha raes are calculable and ha inflaion is 10 percen or less is from 1999, which leaves 10 observaions. In he EA model, he lag inflaion is proxy for he expeced inflaion, which leaves 9 observaions. In he NK model, he lag and he forward inflaion are proxy for he expeced presen and fuure inflaion, which leaves 8 observaions. For he res, he firs years when he daa on levels is complee is 1993 for he Czech Republic, 1992 for Hungary, 1991 for Esonia, 1996 for Lavia and 1994 for Lihuania.The firs period ha raes are calculable and ha inflaion is 10 percen or less is 1994 for he Czech Republic leaving i 15 observaions, 2000 for Hungary leaving i 9 observaions, 1998 for Esonia leaving i 11 observaions, and 1997 for Lavia and Lihuania living hem wih 12 observaions each. In he EA model, he lag inflaion is he proxy for he expeced inflaion, he inflaion from he previous year is calculable, leaving each wih he same number of observaions. In he NK model, he lag and he forward inflaion are proxy for he expeced presen and fuure inflaion, leaving each 1 observaion less. Finally, he value of he dummy variable is 1 for he Czech Republic in 1997 and 1998, and for all Balic Tigers in 2008 represening financial crises periods. The value of he dummy variable for he res is 0. 28

10 5. Resuls The regression resuls are in Table 2 for he EAPC, Table 3 for he NKPC, Table 4 for he EAPC-2 and Table 5 for he NKPC-2. In convenional specificaions, he EAPC capures he negaive parial regression coefficien beween inflaion rae and unemploymen rae more han he NKPC does. In he EAPC, he coefficien is negaive in all and significan for he Czech Republic, Lavia and Lihuania, and also for he panel daa. In he NKPC, he coefficien is negaive in hree of seven runs bu significan for he Czech Republic only. In varian specificaions, he EAPC-2 capures he negaive parial regression coefficien beween inflaion and unemploymen more han he NKPC-2 does. In he EAPC-2, he coefficien is negaive in six of seven runs and significan for he Czech Republic, Hungary, and also for he panel daa. In he NKPC-2, he coefficien is negaive in five of seven runs bu significan for Hungary only. In comparing he EA and he NK specificaions, he resuls are more consisen wih a priori relaionship in he EA. Table 2 EAPC Consan.04.09***.06.04*.09***.05***.07*** Inflaion(-1).65*.23*.37.41*.47***.36***.39*** Unemploymen Rae ** *** -.30** -.33*** Financial Crisis.04**.04*.06***.06***.05*** Czech -.03*** Hungary -.01 Esonia -.02* Lavia -.00 Lihuania -.02** Observaions R F ***.9 5.3** 35.0*** 28.9*** 21.0*** Whie Lagrange Muliplier Table 3 NKPC Consan * Inflaion(+1) ***.92**.60*** Unemploymen Rae * Financial Crisis.04*.03** 29

11 Czech.01 Hungary.02 Esonia.01 Lavia.00 Lihuania -.00 Observaions R F *** *** 4.0* 6.3*** Whie ** Lagrange Muliplier

12 Table 4 EAPC-2 Consan.02.02*.05**.02.03*.01.02** Inflaion(-1).51.44***.18.48***.28.33***.39*** % of (Unemp-Emp) * -.18** ** Financial Crisis.06**.06**.11*.10***.07*** Czech.00 Hungary.02** Esonia.00 Lavia.01 Lihuania -.01 Observaions R F *** 6.9** 5.9** 7.9*** 16.5*** 15.4*** Whie Lagrange Muliplier Table 5 NKPC-2 Consan * Inflaion [(-1)+(+1)]/2 1.33*.61***.09.86**.94***.62***.70*** % of (Unemp-Emp) * Financial Crisis.05**.03*** Czech -.00 Hungary.01 Esonia -.00 Lavia -.00 Lihuania -.01 Observaions R F 5.5* 9.0*** 5.2** 4.6** 35.6*** 30.4*** 18.2*** Whie * * Lagrange Muliplier

13 Beween he wo NK runs, he varian resuls in negaive parial regression coefficien more han he convenion does wih five of seven in he NKPC-2 versus hree of seven in he NKPC. Boh have one significan relaionship; Hungary in he NKPC-2 and he Czech Republic in he NKPC. Also, he varian reflecs a beer fi where all seven F-saisics in he NKPC-2 are significan as compare o four in he NKPC. The regression resuls show ha he beer fi has o do wih he differen proxies for he expeced inflaion. Tha is he average of he lag and forward inflaion predics he presen inflaion beer han he forward inflaion only. In he EA runs, he parial regression coefficien of inflaion rae wih respec o unemploymen rae in he case of convenional specificaion is negaive in all seven runs and significan for he Czech Republic, Lavia, Lihuania and also he panel daa. On he oher hand, he coefficien wih respec o growh rae of unemploymen ne of growh rae of employmen in he case of varian specificaion is negaive in all bu Poland and significan for he Czech Republic, Hungary and he panel daa. Convenional specificaion has 5 of 7 significan overall regressions while he varian specificaion has 6 of 7. By close call, he EAPC ouperforms he EAPC-2 in erms of providing evidence of he negaive relaionship beween inflaion and unemploymen. Noe of he following addiional observaions. The firs observaion is ha each coefficien of he consan in he EAPC is greaer han ha in he EAPC-2. This is shown in Table 6. For example, he coefficien of he consan for he Czech Republic is 0.09 in he EAPC and 0.02 in he EAPC-2. Also noe ha he average inflaion in he coverage of regression run is generally in beween; for example in he Czech Republic, he average inflaion of 5 percen is beween 0.09 and Table 6 Inerceps in EAPC and EAPC-2 Coefficien of he consan EAPC.04.09***.06.04*.09***.05***.07*** EAPC *.05**.02.03*.01.02** Inflaion Average Sd. Dev As inflaion is run wih is lag value, a firs order auo-regression wihin each run is implied in equaions 19 and 21. Tha is, each conains 23. b c. 1 For inflaion o be mean revering, he necessary condiion is 0< c <1 and his condiion holds in all runs. They also mean ha ha inflaion is bounded o b c 32

14 Table 7 shows he resul of calculaing he above, and his gives he second general observaion. Tha is, inflaion in he EAPC is bounded o be much greaer han he average, while inflaion in he EAPC-2 is bounded o approximaely equal he average. Of paricular example is he Czech Republic where he coefficiens of he consan and lag inflaion are significan. Inflaion is bounded o 12 percen in he EAPC and 4 percen in he EAPC-2, while he average inflaion in he coverage of daa is 5 percen. Table 7 Bound of Inflaion according o AR(1) in EAPC and EAPC-2 Coefficien of he consan EAPC.04.09***.06.04*.09***.05***.07*** EAPC *.05**.02.03*.01.02** Coefficien of lag inflaion EAPC.65*.23*.37.41*.47***.36***.39*** EAPC ***.18.48***.28.33***.39*** Inflaion bound EAPC EAPC Inflaion Average Sd. Dev The hird observaion has o do wih he implied long run relaionship beween inflaion and unemploymen. Equaions 19 and 21 imply ha he shor run relaionship beween inflaion and unemploymen is measured by he coefficien a. The sandard view is ha in he long run, expeced inflaion cach up wih acual inflaion; hence =. Hence, he long run versions of equaions 19 and 21 are 25. a a u & ( ). 1 c 1 c Shown in Table 8, he inflaion is more responsive o unemploymen in all case. Pu differenly, he PC is more Keynesian in he shor run and is more Neoclassical in he long run. For example, Lihuania in he EAPC, a decrease of unemploymen rae say from 5 percen o 4 percen pressures inflaion rae o increase by 0.3 percen in he shor run and increase by 0.51 percen in he long run. Anoher example is he Czech Republic in he EAPC-2. A percenage edge in he growh of level of employmen over he growh of level of unemploymen pressures inflaion rae o increase by 0.07 percen in he shor run and increase by 0.13 percen in he long run. The exisence of he naural rae of unemploymen is debaable (Sigliz, 1997). Bu assume i exiss. The fourh observaion is on he implied naural rae of unemploymen given he EAPC. Given 33

15 N N 26. c 1 a( u u ) au c 1 au. Juxaposing equaions 19 and 26, he consan b from equaion 19 and he consan au N from equaion 26 are implied counerpars. Seing he wo equal and hen solving for u N gives N 27. u b / a. Table 9 shows he implied naural rae of employmen. The implied naural raes are far above he average acual unemploymen rae wihin he coverage of he daa. For example, consider he resuls for Lihuania. The implied naural rae of unemploymen is 17 percen. The average unemploymen rae in he coverage of he daa is 11 percen. Of he 12 observaions, he acual rae of unemploymen is greaer han he implied rae only once, bu is less han in 11 of 12 observaions. Eiher he naural rae of unemploymen does no exis, ime varying or no capured because he relaionship beween inflaion and unemploymen rae is ambiguous. EAPC Coefficien of -1 Shor run coefficien Implied long run coefficien EAPC-2 Coefficien of -1 Table 8 Long Run Relaionship beween Inflaion and Unemploymen.65*.23*.37.41*.47***.36***.39*** ** *** -.30** -.33** ***.18.48***.28.33***.39*** Shor run coefficien * -.18** ** Implied long run coefficien Coefficien of he consan (b) Coefficien of unemploymen (a) Implied naural rae of Table 9 Implied Naural rae of Unemploymen from he EAPC.04.09***.06.04*.09***.05***.07***.19.91** ***.30**.33**

16 unemploymen Average unemploymen rae Greaer-less han implied Conculusion In convenion, he relaionship beween price and unemploymen is expressed in erms of he PC where he rae of change of price hrough ime or inflaion is relaed wih he rae of unemploymen a a ime; ha is price is dynamic and unemploymen is saic. In varian specificaion, he relaionship beween price and unemploymen are expressed boh in heir dynamic saes. In convenion, he ransformaion from he AS curve o he PC curve is ambiguous. For example, boh price and oupu are levels wihou limis in he AS curve whereas price as represened by inflaion is rae wihou limi and unemploymen as represened by is rae is limied o 100 percen. In he varian specificaion, he raes of change of price (inflaion), unemploymen and employmen jus like in he AS are wihou upper limis. Individual and combined regression ess are conduced on he CE-3 and he Balic Tigers. Beween he Neoclassical expecaions augmened (EA) and he NK specificaions, he EA is beer able o rack he negaive relaionship beween inflaion and unemploymen. Beween he NK specificaions, he varian specificaion is more able o resul in overall significance han he convenional specificaion is able. Bu he significance is probably more o do wih he relaionship beween presen inflaion and he average lag and forward inflaions, and less o do wih he relaionship beween inflaion and growh rae of unemploymen ne of growh rae of employmen. Beween he EA specificaions, he convenional specificaion racks a negaive relaionship beween inflaion and unemploymen in all runs wih four of seven being significan, while he varian specificaion racks a negaive relaionship in six of seven runs wih hree of seven being significan. Some observaions mus be noed. One is ha inflaion is mean revering and he mean inflaion in he varian specificaion is more sensible han in he convenional specificaion owing ha he former is closer o he acual average inflaion in he coverage of he daa. Anoher is ha he PC is seeper in long run han in he shor run and his finding is consisen wih sandard heory. Finally, he implied naural rae of unemploymen in convenional specificaion is far greaer han he average unemploymen rae in he coverage of he daa. 35

17 Reference Ball L (2000): Near Raionaliy and Inflaion in Two Moneary Regimes. NBER Working Paper No Ball L and Mankiw NG (2002). The NAIRU in Theory and Pracice. Journal of Economic Perspecives 16(4): Blanchard O and Gali J (2007): Real Wage Rigidiies and he New Keynesian Model. Journal of Money Credi and Banking, 39(1): Blanchard O and Kaz L (1997): Wha We Know Abou he Naural Rae of Unemploymen. Journal of Economic Perspecives, 11(1): Calvo G (1983): Saggered Conracs in a Uiliy-Maximizing Framework. Journal of Moneary Economics, 12(3): Daniskova K and Fidrmuc J (2011): Inflaion Convergence and he New Keynesian Phillips Cuve in he Czech Republic. AUCO Czech Economic Review, 5: Dornbusch R, Fischer S, and Sarz R (2001): Macroeconomics, Eighh Ediion. McGraw- Hill Irwin, New York. Dumlao L (2012): The Relaionship Beween Dynamic Price and Dynamic Unemploymen: he Case of Malaysia, he Philippines, Singapore and Thailand. Inernaional Journal of Economic Perspecives, 6(3). Friedman M (1968): The Role of Moneary Policy. American Economic Review, 58(1): Fuhrer JC (1997): The (Un)Imporance of Forward-Looking Behavior in Price Specificaions. Journal of Money, Credi and Banking, 29(3): Gali J and Gerler M (1999): Inflaion Dynamics: a Srucural Economeric Analysis. Journal of Moneary Economics, 44: IMF (2011): World Economic Oulook: Sepember Rerieved from hp:// Keynes JM (1936): The General Theory of Employmen Ineres and Money Reprined McMillan, New York. Lipsey RG (1960). The Relaion beween Unemploymen and he Rae of Change of Money Wage Raes in he Unied Kingdom. Economerica, 27(105): McCallum B (1976): Raional Expecaions and he Naural Rae: Some Consisen Esimaes. Economerica, 44(1):

18 Phillips AW (1958): The Relaionship Beween Unemploymen and he Rae of Change of Money Wages in he Unied Kingdom Economica, 25: Robers J (1995): The New Keynesian Economics and he Phillips Curve. Journal of Money, Credi and Banking, 27(4): Roemberg J (1982): Sicky Prices in he Unied Saes. Journal of Poliical Economy 90(6): Rudd J and Whelan K (2005): New Tess of he New-Keynesian Phillips Curve. Journal of Moneary Economics, 52(6): Sleeman AG (2011): Rerospecives: he Phillips Curve: a Rushed Job? Journal of Economic Perspecives, 25(1): Sigliz J (1997): Reflecions on he Naural Rae Hypohesis. Journal of Economic Perspecives Volume 11(1): Taylor J (1979): Saggered Conracs in a Macro Model. American Economic Review, 69(2):

19 Appendix 1 The Price of Oil as a Supply Side Shock The inserion of he dummy variable represening financial crises years is necessary o ake ino accoun of exogenous shifs of he AS and PC curves. Alernaively, his secion shows he resuls if one uses he rae of increase of he domesic price of oil o proxy for he exogenous shifs of he AS and PC curves. The US dollar price of oil is he price per barrel which is downloaded from The price is convered o domesic price using he exchange raes aken from he Bank of Esonia (or he cenral bank of Esonia) hrough hp://saisika.eesipank.ee/?lng=en#reemenu/valuuta. The rae of increase of he domesic price of oil is insignifican excep in he rare resul for Poland in he EAPC and EAPC-2 and Esonia in he NKPC. However, all financial crisis dummy is posiive and significan in all runs in he main ex. Table A1-1 - EAPC Consan * -.08*.06**.08*** Inflaion(-1).68** *.85**.63**.60*** Unemploymen Rae ** -.41** -.42*** Oil.07** Czech -.03*** Hungary -.03** Esonia -.02* Lavia -.01 Lihuania.02* Observaions R F 6.6*** *** 5.6** 9.6*** Table A1-2 NKPC Consan Inflaion(+1) *** Unemploymen Rae Oil * Czech.00 Hungary.02 Esonia.00 Lavia -.00 Lihuania -.00 Observaions R

20 F *** 2.7* 4.8*** Table A1-3 EAPC-2 Consan ** Inflaion(-1).77* *.73*.61*** % of (Unemp-Emp) ** Oil.08** Czech.00 Hungary.01 Esonia.01 Lavia.01 Lihuania.00 Observaions R F 4.7**.8 4.6**.9 5.0** *** Table A1-4 NKPC-2 Consan * Inflaion [(-1)+(+1)]/2 1.28** **.95***.79***.86*** % of (Unemp-Emp) * Oil Czech -.00 Hungary.00 Esonia -.00 Lavia -.00 Lihuania -.01 Observaions R F 7.6*** ** 3.4* 16.0*** 9.1*** 9.9*** 39

21 Appendix 2 Running he including Hyperinflaionary Transiion Periods The coverage of daa esing begins when he economies become normal capialisic economies and he assumpion is ha his begins when inflaion reach 10 percen or less for he firs ime. The succeeding ables show he regression resuls when all daa are included including hyperinflaionary periods. The regression resuls for Poland, he Czech Republic and Lavia are no shown given ha he daa used in he main ex is he same as here and hence wihou ransiion daa. In he varian specificaion, he relaionship beween inflaion and unemploymen is never significan. In convenional specificaion, he same is significan in wo of four runs for each he EAPC and he NKPC, bu all wih posiive signs which is couner inuiive. Table A2-1 EAPC Consan -.08* Inflaion(-1).48***.08***.17***.09*** Unemploymen Rae 1.72** * Financial Crisis Czech.05 Hungary.12*** Esonia.08** Lavia.04 Lihuania.06* Observaions R F 37.5*** 15.9*** 23.3*** 24.2*** Table A2-2 NKPC Consan *** -.10** Inflaion(+1).62** 1.90*** 1.67*** 1.57*** Unemploymen Rae ***.54** Financial Crisis.02 Czech.04 Hungary -.00 Esonia.04 Lavia -.00 Lihuania.03 Observaions

22 R F 27.2*** 149.8*** 202.0*** 70.1*** 41

23 Table A2-3 EAPC-2 Consan.01.10*** Inflaion(-1).85***.06***.54***.08*** % of (Unemp-Emp) Financial Crisis **.03 Czech.01 Hungary.08** Esonia.06* Lavia.02 Lihuania.03 Observaions R F 23.8*** 19.2*** 103.9*** 20.3*** Table A2-4 NKPC-2 Consan.00.10*** Inflaion [(-1)+(+1)]/2.98***.12***.85***.15*** % of (Unemp-Emp) Financial Crisis.03 Czech.01 Hungary.08** Esonia.06* Lavia.01 Lihuania.03 Observaions R F 36.0*** 31.0*** 217.4***