EMPIRICAL ANALYSIS OF THE RELATIONSHIP BETWEEN THE UNEMPLOYMENT AND INFLATION

Abstract

Unemployment and inflation are two extremely important macroeconomic indicators, which have great influence on economic stability. Every government strives to achieve low level of unemployment and inflation. However, many empirical studies have shown that there is inverse relationship between unemployment and inflation. High unemployment means higher supply than demand for jobs, and consequently, the employers are not stimulated to increase the wages. Stable and low wages do not further impose any pressure on prices, and inflation remains low. Contrary, low level of unemployment is related with the greater demand than supply of jobs, that will boost the salary higher and finally will increase the production costs as well as the overall demand in the economy. Ultimately, that will cause higher inflation in the economy.These statements were confirmed by the Phillips researches. The Phillips curve was projected, by which it was possible to predict the rate of unemployment at certain rate of inflation, and vice versa. Though, this curve was exceptionally useful till 70s – 80s of the last century, in the period after, L-shaped Phillip curve held only for explaining short-term relationship, but did not hold for explaining long-term relationship. It means that in the later period inter-relation between unemployment and inflation was unstable.Macedonia has faced many challenges in the period right after the independence – enormously high unemployment, hyperinflation and negative rate of GDP. This period is known as “stagflation”. It was exceptionally difficult to improve all these economic indicators, simultaneously. They were inversely related, and it was impossible to improve one indicator, without worsening the other in the same time. Such situation was disproving the existing statements that high unemployment is related with low inflation, and vice versa. Phillip curve in this case, definitely does not hold. Although the situation now is different, it is still very important to determine the inter-relationship between the unemployment and inflation. The truth is that more than 20 years the country does not have any problems with high inflation, but also the fact is that high rate of unemployment is still great concern. Hence, in order to promote suitable government policies, it is important to know the inter-relationship between unemployment and inflation.With a purpose to determine the mutual influence between two variables, we have conducted an empirical research, using the contemporary econometric software EViews 9.5. The analysis is for the period 1993-2018. The data were collected from National bank of the Republic of Macedonia, State Statistical Office of the Republic of Macedonia and the World Bank database. We have performed the Johansen Co-integration Test, as well as the Granger Causality Test. The results have shown that there is 1 co-integration between variables and that there is not granger causality between the variables. Consequently, the past values of unemployment can not be used for predicting the future values of inflation, and vice versa. Furthermore, the research is evidence that the Phillip curve does not hold for Macedonia and the rate of one variable can not be used for determination of the values of the other variable.