The Effect of Incomes Policies on Inflation in Bulgaria and Poland

Transition countries, and many other countries with incomplete markets, have faced long periods with both high inflation and unemployment. Policies to reduce inflation without high unemployment include incomes policies, which were widely employed in transition countries. This paper studies the effects of incomes policies on inflation in Bulgaria and Poland in 1990-1993. The actual policies, which were complex and changing, are examined. The policies do not appear well-designed in a technical sense to reduce inflation. A time-series analysis is made which includes standard determinants of inflation including past inflation, wage increases, exchange rate changes, and monetary changes, plus a dummy for incomes policies. The regressions are fairly successful in fitting standard factors that should influence inflation, particularly the exchange rate and unemployment in Bulgaria and wages and unemployment in Poland. They find a fairly substantial inflation-reducing effect from the Bulgarian policy but no significant results from the Polish policy. This revised version was published online in July 2006 with corrections to the Cover Date.     

The London Business School with Gower Publishing: Forecast Release: EARNINGS AND UNEMPLOYMENT IN THE CAR INDUSTRY: THE BEST AND WORST OF BRITISH INDUSTRY

The Chancellor has described the cost in terms of lost output and higher unemployment of getting inflation down as ‘well worth paying’. Yet the trade-off so far is a miserable 1.25 per cent off the underlying rate of growth of earnings for an unemployment increase approaching 600,000, some 2–3 per cent off the underlying rate of inflation for a 3 per cent drop in GDP and a 7 per cent fall in manufacturing output. The question is clear: why is it that in the UK we seem to have to pay such a high price in terms of lost output and higher unemployment to make only modest progress on reducing wage and price inflation? One possible answer is in terms of the NAIRU; another stems from the way in which we measure retail price inflation. Using the example of the car industry as a backdrop, we examine the relationship between unemployment and inflation and ask whether there is a role for government to play in improving the trade-off. Our conclusion is that the present non-interventionist stance is probably appropriate but that the government should be doing more to educate both sides of the wage bargain - a challenge picked up by the Prime Minister in his recent speech to the CBI. This is especially appropriate at the present time, because price inflation is falling but wage inflation is lagging behind. It is not a cut in real wages that is required but an equi-proportionate deceleration in both wages and prices. By joining the ERM, we will ultimately obtain German rates of inflation; low wage settlements would both shorten the time-scale and reduce the unemployment cost of convergence.     

Long-term Unemployment and the Labour Market: some further results

In a previous Briefing Paper we discussed the current high rate of long-term unemployment. We described the process by which the ratio of long-term unemployment to total unemployment was determined and suggested some explanations for the rapid rise in long-term unemployment since 1980. We also investigated the role of long-term unemployment in shifting the relationship between unemployment and vacancies. In this Briefing Paper we extend our study to consider the relationship between unemployment and inflation. In particular we discuss the apparent failure of high unemployment to affect the growth of real wages. Finally we compare some policies for reducing unemployment.     

The Australian Economy - Thatcherism after 7 Years?

In March 1983 Mr Malcolm Fraser's Liberal Coalition was defeated in the Australian general election. He had held office for over 7years. His Government's record on economic management can be briefly summarised as follows. At the end of 1975 when the Liberal Coalition took office the inflation rate was 14 per cent and the rate of unemployment was 5.4 per cent; in March 1983 the inflation rate was 11.5 per cent and the rate of unemployment was 10.4 per cent. It is generally thought that Mr Fraser's policies were not unlike those of Mrs Thatcher. Since he had been operating them for over seven years it is reasonable to ask why the outcome appears to have been so disappointing. In this Briefing Paper we examine recent developments in the Australian economy and make some comparisons of policies and outcomes in Australia and Britain, particularly during the past four years, when there were conservative Governments in both countries.     

Will Labour’s Economic Programme Work?

If Labour is elected to government on 1 May, it will inherit the lowest inflation of any incoming government over the last fifty years but the highest unemployment. At the same time, public borrowing is running at an unsustainable high level. In this article, Andrew Sentance examines Labour's plans to expand employment while reducing public borrowing and containing inflation. He argues that Labour's economic programme could work but a number of pitfalls need to be avoided. Monetary policy will need to be tightened after the Election and the fiscal squeeze implied by Conservative spending plans maintained – if necessary through higher taxes. The benefits from Labour's employment policies could also be undermined by a high minimum wage, particularly if applied to young workers.     

PHILLIPS CURVES AND UNEMPLOYMENT DYNAMICS: A CRITIQUE AND A HOLISTIC PERSPECTIVE

Abstract.  The conventional wisdom that inflation and unemployment are unrelated in the long run implies the compartmentalization of macroeconomics. While one branch of the literature models inflation dynamics and estimates the unemployment rate compatible with inflation stability, another one determines the real economic factors that drive the natural rate of unemployment. In the context of the new Phillips curve, we show that frictional growth, i.e. the interplay between lags and growth, generates an inflation–unemployment trade-off in the long run. We thus argue that a holistic framework, such as the chain reaction theory (CRT), should be used to jointly explain the evolution of inflation and unemployment. A further attraction of the CRT approach is that it provides a synthesis of the traditional structural macroeconometric models and the (structural) vector autoregressions.     

Why has inflation fallen?

There is no doubt that the most encouraging aspect of Britain's economic performance in recent years has been the fall in inflation from a peak of over 20 per cent in June 1980 to a current rate of about 5 per cent. The speed at which inflation fell has taken many forecasters (including ourselves) by surprise. In this Economic Viewpoint we ask why the inflation rate has fallen. If we can understand why it has happened we are better placed to answer questions about the future. In particular we can try to decide whether the success in reducing inflation will be maintained and whether further cuts in inflation will be consistent with a fall in unemployment.     

Whatever Happened to Goldilocks? The Role of Expectations in Estimates of the NAIRU in the US and the UK*

During the second half of the 1990s the US economy was characterized as the Goldilocks economy: not too hot, nor too cold, but just right. It was argued that this represented a new paradigm, enabling unemployment to remain low without igniting inflationary pressure. We examine the evidence for a change in the relationship between inflation and unemployment for the US and UK using Phillips curve models. The impact of including explicit inflation expectations is also considered. Inflation expectations are found to play an important role, particularly in the US. When expectations are included there is still evidence that the non‐accelerating inflation rate of unemployment (NAIRU) steadily declined during the late 1990s, although this decline in the US NAIRU is not found solely in the 1990s.     

A MORE FLEXIBLE LABOUR MARKET?

The firm downward trend in unemployment has been one of the most surprising aspects of the UK recovery to date. Unemployment has fallen at a much earlier stage of recovery than it did in the 1980s, despite the fact that measured growth has been fairly modest to date. More favourable demographic trends have contributed to this decline, as has early retirement and an expansion of higher education. It is also possible that growth is being understated. However, the decline in unemployment has also led to the suggestion that the UK labour market has become more flexible. In this Forecast Release, we examine this claim. We identify a number of ways in which both the demand for and the supply of labour have become more flexible. But in one crucial respect - real wage flexibility - the evidence is less persuasive. That should not prevent unemployment falling in the short term. But it could limit the extent to which a substantial further fall in unemployment could he sustained without inflation re-emerging.     

Nonlinearities and Fractional Integration in the US Unemployment Rate*

This paper proposes a model of the US unemployment rate which accounts for both its asymmetry and its long memory. Our approach introduces fractional integration and nonlinearities simultaneously into the same framework, using a Lagrange multiplier procedure with a standard null‐limit distribution. The empirical results suggest that the US unemployment rate can be specified in terms of a fractionally integrated process, which interacts with some nonlinear functions of labour‐demand variables such as real oil prices and real interest rates. We also find evidence of a long‐memory component. Our results are consistent with a hysteresis model with path dependency rather than a non‐accelerating inflation rate of unemployment (NAIRU) model with an underlying unemployment equilibrium rate, thereby giving support to more activist stabilization policies. However, any suitable model should also include business cycle asymmetries, with implications for both forecasting and policy‐making.     

Subsidizing low-skilled jobs in a dual labor market

We introduce a matching model that allows for classical and frictional unemployment. The labor market is dual featuring low-skilled and high-skilled workers and simple and complex jobs. Simple jobs pay a minimum wage, while wages in the complex jobs are determined by Nash bargaining. Opportunities for low-skilled workers are limited to simple jobs; while high-skilled unemployed can apply for both types of jobs, and thereby can accept to be downgraded. We analyze the outcomes of simple job subsidy policies assuming that government budget is balanced through taxes on occupied workers. We first give conditions for the existence and uniqueness of a steady-state equilibrium and we then analyze the effects of different fiscal instruments. We show that in this set-up, increasing simple job subsidies does not necessarily reduce low-skilled unemployment or unemployment spells. By introducing heterogeneous skills and possible downgrading of the high-skilled workers, we show that the effectiveness of such policies in reducing the classical unemployment is decreasing. In fact, any additional classical unemployed re-entering the job market is accompanied by an increasing number of high-skilled workers downgrading to low-skilled jobs. We calibrate the model on French labor market data. It is found that for five low-skilled workers leaving classical unemployment, two high-skilled workers are downgraded.     

Planning Feature The Forecast in Detail: [4] Focus: Unit Labour Costs in Manufacturing Industry and the Outlook for Price Inflation

The latest figures show that unit labour costs in manufacturing rose 8.9 per cent in the year to March, the highest rate of increase since 1981 (when costs were decelerating) and a sharp contrast with 1983 when, for a brief period, COSD were stable. In this Focus we examine how this development has occurred and consider its implications. We conclude that the recent figures represent a temporary deterioration in the costs of manufacturing industry and that, once output picks up again and as long as wages respond to the current low rate of inflation, there should be no severe adverse consequences on either inflation or output. If, however, costs are not controlled then the outlook for either inflation or output and unemployment is worse than our central forecast suggests.     

Executive Summary

Our assessment of the outlook for the UK economy over the next two years has become slightly more cautious in the wake of the additional fiscal tightening announced in the November Budget. Although we had anticipated tax and public spending measures of the right magnitude in 1994/95, the Budget was more severe in 1995/96 and beyond than we had expected. We have scaled back our estimates of growth for 1995 and 1996 accordingly. On a more positive note, we expect the outlook for inflation to be better than we indicated last October. The mid-1990s are' likely to see a period of sustained low inflation which has not been seen since the 1960s. The government's target measure - RPI excluding mortgage interest - is not expected to test the 4 per cent target ceiling though it is stuck in the 3-3.5 per cent range for most of the forecast period. Despite expecting slower growth, we are now more optimistic about unemployment, which we expect to fall below 2.4 million in 1997. We now believe that increased labour market flexibility should allow the economy to grow on a lower real wage and productivity growth path, at least while unemployment remains so high. However, whether this improved performance would allow the UK to sustain an unemployment of below 2 million without a serious resurgence of inflation is still open to question.     

A Bounded Model of Time Variation in Trend Inflation,Nairu and the Phillips Curve

In this paper, we develop a bivariate unobserved components model for inflation and unemployment. The unobserved components are trend inflation and the non‐accelerating inflation rate of unemployment (NAIRU). Our model also incorporates a time‐varying Phillips curve and time‐varying inflation persistence. What sets this paper apart from the existing literature is that we do not use unbounded random walks for the unobserved components, but rather bounded random walks. For instance, NAIRU is assumed to evolve within bounds. Our empirical work shows the importance of bounding. We find that our bounded bivariate model forecasts better than many alternatives, including a version of our model with unbounded unobserved components. Our model also yields sensible estimates of trend inflation, NAIRU, inflation persistence and the slope of the Phillips curve. Copyright © 2015 John Wiley & Sons, Ltd.     

Price Inflation in the UK: Has Anything Changed?

Since leaving the ERM, the UK has had low inflation while unemployment has fallen substantially. This suggests that wage and price behaviour may have changed over the recent past. In this article, Ken Coutts and Brian Henry review the evidence for such change, particularly in pricing behaviour, but find little convincing evidence of a major structural shift. Rather, low inflation can be attributed to the effect of weak demand and low capacity utilisation on prices (and wages) which are larger and longer lasting than is generally believed, together with beneficial effects from low world inflation. On leaving the ERM, the government also instituted a classic combination of expenditure-switching and expenditure-reducing policies which played an essential part in promoting recovery without increasing inflation.     

Europeanization or globalization? Transnational wage bargaining and the distribution of activity in European labor markets

This paper investigates the impact of globalization on labor markets, in terms of wage inflation and the distribution of activity across regions. Specifically, we study the effects of aggregation in the labor markets on the distribution of employment and inflation pressures, where there are differences in market structures and transmission mechanisms underpinned by relatively immobile labor. To demonstrate these ideas, we take the European experience as a “laboratory” to show what can be expected from globalization in the labor markets in practice. Using models of wage leadership vs. locational competition, we examine the extent and strength of aggregation effects on labor market costs using a sample of data from 1983 to 2007 which covers the period of the creation of the Euro. We find that the aggregation effect has decreased significantly since the start of EMU, improving the trade-off between inflation and unemployment. At the same time, while Germany played an important role in the run-up to EMU in terms of wage leader, its role has now decreased and been replaced by globalization forces. This implies increased locational competition in terms of wage formation. We demonstrate this with the emerging role of the US as the benchmark for wage setting in Europe.     

Unemployment and gang crime: can prosperity backfire?

In this paper, we study how unemployment affects gang crime. We examine a model of criminal gangs and suggest that a substitution effect between petty crime and severe crime is at work. In the model, non-monetary valuation of gang membership is private knowledge. Thus, the leaders face a trade-off between less crime per member in large gangs and more crime per member in small gangs. A decrease in unemployment may result in a switch from a large gang that requires petty crime to a small gang that requires severe crime.     

Informality in developing economies: Regulation and fiscal policies

This paper proposes a unified theoretical framework where formal and informal firms coexist and face the same type of product and labor market imperfections: they have monopoly power in the goods market, they are subject to matching frictions in the labor market, and wages are determined by bargaining between large firms and their workers, through either individual or collective bargaining. Our model matches the main stylized facts on informality for developing countries and appears to be a good candidate for policy analysis. In this framework, we study the impact on informality, wages and unemployment of policies that may be used to reduce informality. We consider changes in product market regulation (PMR) and in two types of fiscal policies, labor taxes and formality enforcement. We find that lessening PMR decreases informality and unemployment simultaneously, indicating that there is not necessarily a tradeoff between informality and unemployment. The tradeoff appears when fiscal policies are used, though. Moreover, the impacts of PMR on unemployment and on wages are larger under collective than individual bargaining. With respect to wage inequality, lessening PMR reduces it, while lower taxes tend to increase the formal sector wage premium.