Academic journal article Journal of Business Economics and Management

The Nexus between Prices, Employment and Output Growth: A Global and National Evidence

Academic journal article Journal of Business Economics and Management

The Nexus between Prices, Employment and Output Growth: A Global and National Evidence

Article excerpt

Introduction

Knowledge of the linkages between employment growth, inflation and output growth is essential for designing policies not resulting in "overshooting" or "undershooting" of the targeted "equilibrium", as well as for choosing optimally the particular inflation rate, level of economic activity or "natural rate of unemployment" that should be targeted. Further, it might also be instrumental in reducing economic cycles.

In two famous studies Phillips (1958, 1962) analysed the relationship between unemployment and the rate of change of nominal wages in the United Kingdom and that between employment growth, inflation, and output growth. Studies identifying negative inflation-growth link find variability of inflation to be harmful for growth. Price volatility discourages investments and lowers production efficiency lowering future profitability through uncertainty. In condition of low investments and rising prices balance of payments becomes a real problem. Several studies support the thesis that inflation is harmful for growth. Bruno and Easterly (1996, 1998) find a negative correlation for inflation and growth with high price volatility (40%). Burdekin et al. (2004) find that inflation is harmful to growth in industrialised countries only when the price level hits 9%, whilst the threshold is 3% in the developing economies. Lopez-Villavicencio and Mignon (2011) supply strong evidence of a non-linear negative link between inflation and growth with a threshold effect. Other studies highlight positive impact of inflation on growth through real interest rate - long run investment rate mechanism. Tobin (1965) argued that there is a positive impact of inflation on growth through capital accumulation (lower marginal productivity of capital and real interest rates). In the presence of inflation, investors face lower returns on monetary assets relative to real assets (physical capital). Benhabib and Spiegel (2009) provide evidence that inflation positively affects growth below a 5% price threshold level.

Employment and output growth are closely connected through the productivity-wage mechanism (Scott, McKean 1964). Output growth followed by sharp increase in the wage rates (above productivity rate) results in profitably fall and increasing unemployment in the long run. Okun (1962) documented a negative relationship between changes in the unemployment rate and output growth. Lee (2000) finds empirical support for Okun's law in most OECD countries. Malley and Molana (2008) report a threshold effect in the unemployment rate. Eriksson (1997) finds a trade-off between unemployment and long-run growth in the steady state. Dhont and Heylen (2008) suggest that differences in employment and output in Europe and the US arise from differences in the structure of fiscal policy. Other studies trying to explain movements in (un)employment and prices include Phelps (1967, 1968), Berentsen et al. (2011), Ericsson and Tryon (2001), Fernandez Valdovinos (2003), Barro (1996), Mollick et al. (2011). Monetary aggregates could also have an important role as explored in Bozoklu (2013). Oil pass-through effect as in Catik and Karacuka (2012) validates hypothesis of low inflationary environment associated with low pass-through. The series also show long memory behavior (Skare, Stjepanovic 2013). Oil prices shocks and associated monetary policy response exhibits different influence on price and output fluctuations (Semko 2013).

The layout of the paper is as follows. Section 1 describes the data and the econometric framework. Section 2 presents the empirical results. Section 3 summarises the main findings and discusses their implications for successful macroeconomic policy design.

1. The model and data

1.1. Data

Our dataset is a balanced panel with annual data on employment, prices and output from 1970 to 2010 for 119 countries (1). The variables are in annual percentage changes. The data sources are the USDA International macroeconomic dataset (historical data files) and the Conference board total economy database 2011. …

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