IMPACT OF INFLATION ON UNEMPLOYMENT IN THE REPUBLIC OF MACEDONIA

Journal of Business Paradigms Vol 1 No 1, 2016 IMPACT OF INFLATION ON UNEMPLOYMENT IN THE REPUBLIC OF MACEDONIA Elsana Aqifi 1 State University of Tetovo Raimonda Duka University of Tirana ABSTRACT Unemployment as a social phenomenon is today present worldwide and often countries have been forced to take extremely large steps to overcome this social challenge. On the other hand, inflation or price instability, represents a macroeconomic infliction and it is considered to be a concern for a country's economy. Although the costs of inflation are less visible than the costs of unemployment, they also bring significant losses to the economy of the country resulting in redistribution of wealth between classes or echelons of different asset distributions, inefficient resource production and decrease in the value of money. Among the various opinions of various schools associated with macroeconomic stability, the key indicators of macroeconomic stability are inflation, unemployment, balance of payments and increased output. Any worsening of these variables leads to macroeconomic instability. Therefore, the purpose of this paper is to present the relevance and impact of inflation on unemployment in Macedonia from the period between 1998-2013 in trying to define an optimal level of the inflation rate, which will not be detrimental to the economic development of this country. It should be noted that following the procedure of Puzon (2009), who used "the augmented version of Stiglitz's model" to capture inflation expectations, the lag of the first order of inflation is included in the model as a measure of the expected rate of inflation. Key words: macroeconomic issues, inflation, unemployment JEL Classification: P24, E23, O11 1 Address correspondence to Elsana Aqifi, Ph.D Candidate, State University of Tetovo, Tetovo, Republic of Macedonia. E-mail: elsanaejupi@yahoo.com 1

Impact Of Inflation On Unemployment Elsana Aqifi, Raimonda Duka INTRODUCTION Inflation and unemployment represent two of the main economic problems, while any macroeconomic policy objective is to reach a sustainable economic growth with a low rate of inflation and unemployment. Unemployment as a social phenomenon is present worldwide today and often countries have been forced to take extremely large steps to overcome this social phenomenon. On the other hand inflation, or price instability, represents a macroeconomic disease and is considered to be a concern for a country's economy. Although the costs of inflation are less visible than the costs of unemployment, they also bring significant losses to the economy of the country resulting in redistribution of wealth between classes or echelons of different asset distribution, inefficient resource production and decrease in the value of money. Among the various opinions of various schools associated with macroeconomic stability, the key indicators of macroeconomic stability are inflation, unemployment, balance of payments and increased output. Any worsening of these variables leads to macroeconomic instability. Therefore, the purpose of this paper is to present the relevance and impact of inflation on unemployment in Macedonia from the period 1998-2013 in trying to define an optimal level of inflation rate, which will not be detrimental to the economic development of this country. It should be noted that following the procedure of Puzon (2009), who used "the augmented version of Stiglitz's model" to capture inflation expectations, the lag of the first order of inflation is included in the model as a measure of the expected rate of inflation. LITERATURE REVIEW (Phillips 1958) graphically concludes a significant inverse relationship between change in wages and unemployment rates. He submitted that the higher the difference in wages, the lower the unemployment rate and vice versa. Based on the conclusion of Phillips, (Samuelson and Solow 1960) find an empirical relationship between the inflation rate and the unemployment rate in the US. According to M. Friedman (1977), the relationship between inflation and unemployment has gone through three steps. The first step was the acceptance of a stable "trade-off" or an inverse relation between inflation and unemployment (lasting Phillips curve). The second step has been the introduction of inflation expectations as a variable that has changed the short-term Phillips curve and the natural rate of unemployment by setting a long-term vertical Phillips curve. The 2

Journal of Business Paradigms Vol 1 No 1, 2016 third step is caused by an empirical phenomenon of a significant positive relationship between inflation and unemployment. The 90's saw high inflation coupled with high unemployment and the Phillips curve during this period was marked by a positive slope it wasn t vertical. The second step, as explained above, has been influenced by two major developments in economic theory: analysis of imperfect information and its acquisition cost and the role of human capital in determining the shape of the labor contracts. As the third step, a subsequent important development is the application of economic analysis to political behavior. Of relevance is that the obvious positive correlation between inflation and unemployment has been a source of great concern to government policymakers during this period. (Ball-Moffitt 2001), (Koenig 2000), (Brayton-Roberts-Williams 1999), and (Staiger-Stock- Watson 2001) emphasize the role of the revival of productivity growth in keeping inflation down, some directly and some work otherwise through an increase in profit margins making it possible due to a delay in the growth of real wages after the acceleration of productivity. (Karanassou, et al. 2003) have examined the long-term empirical relationship between inflation and unemployment, using a panel data study for European countries. They concluded that there is a long-term trade-off between inflation and unemployment in the case of European countries. (Beyer and Farmer 2007) investigated the association between unemployment and inflation using the database for the US from 1970-1999. They found that there is a direct relationship between inflation and unemployment in the US in the long run. Studies made by (Schreiber and Wolters 2007) and (Franz 2005) analyze whether there dominates a long-term trade-off between inflation and unemployment in Germany, or if there is a positive relationship between them. Both studies concluded that there is an inverse relationship between inflation and unemployment in the long term in the case of Germany. (Berentsen, et al. 2008) have explored the relationship between inflation and unemployment in the US for the period from 1955 to 2005. They concluded that there is a positive relationship between inflation and unemployment, and they also found a positive relationship with regard to the frequency after filtering higher movements. (Popovic 2009) conducted a survey on inflation and unemployment in the EU: a comparative analysis of Phillips regularity by analyzing the correlation between unemployment and inflation in the EU for the period 1998-2007 revealed that the simple linear correlation coefficient between them is negative. 3

Impact Of Inflation On Unemployment Elsana Aqifi, Raimonda Duka They concluded that the relationship between unemployment and inflation is moderate and negative. (Ansari, et al. 2011) have used correlation analysis in a multiple time series between the inflation rate, the employment rate and the rate of the gross domestic product. They use the time series data from 1982 to 2006 in Malaysia. They used the econometric techniques Unit Root Test, the Cointegration Test and the Granger Causality Test. The overall results indicate that inflation and employment rights relate to the GDP in the short term. (Aminu and Anono 2012) used OLS, ADF for the unit root, Granger Causality, Johansen cointegration, and ARCH and GARCH techniques. The study found a negative relationship between inflation and unemployment and no causality between unemployment and inflation; although they found that there exists a long-term relationship between the two phenomena in Nigeria. (Chu, et al., 2013) analyzes the effects of inflation in the long run between unemployment and economic growth. Given the limitations of the CIA for R & D, high inflation, which increases the opportunity cost of holding cash, leads to a decline in innovation and economic growth, which in turn reduces the labor market and increased unemployment. The model predicts a positive relationship between inflation and unemployment, a negative relationship between inflation and R & D, and a negative relationship between inflation and economic growth. METHODOLOGY Description of data and resources During this analysis 16 observations are used. Inflation, annual percentage change in real GDP, and unemployment rate are all taken from the database of the International Monetary Fund. If regression variables are not stationary, then it can be proven that the asymptotic analysis standard assumptions are not valid. T tests will not follow a normal distribution (t-student), so they cannot test common hypotheses. (Dickey and Fuller, 1979), and (Fuller 1976) are the first researchers to formally test the unitary presence of a decrease in the time series. The main objective is to test the null hypothesis (H0) that the series contains a unitary root or alternative hypothesis (H1) that the series is stationary. 4

Journal of Business Paradigms Vol 1 No 1, 2016 Based on the literature and the objectives of this study, the regression model is specified in the order as follows: Ku, = + + + + + = unemployment rate = inflation rate = Annual change in real GDP as an indicator of economic growth It should be noted that following the procedure of (Puzon 2009), who used "the augmented version of Stiglitz's model" to capture inflation expectations, the delay of the first order of inflation is included in the model as a measure of the expected rate of inflation. Moreover, a delay of the first order of unemployment is also included to determine if they can facilitate a better fit of the model as it has been presented (Puzon 2009). Following are the assumptions for signs of the explanatory variables: inflation, as stated by the Philips curve is negatively correlated with unemployment. That is, if the demand for labor increases due to an expansionary monetary growth, the unemployment rate will decrease, causing the ratio wage/prices rise and thus, create a trade-off between inflation and unemployment. Delay of unemployment is positively related to unemployment where unemployment will increase the likelihood of the current unemployment rate, if workers are able to find a job. Based on Okun's law, one would expect that if the coefficient of Okun's is negative, it follows that a rapid increase in production is associated with a decrease in the unemployment rate and slow economic growth or a negative relationship associated with a high unemployment rate (Knotek, 2007). 5

Impact Of Inflation On Unemployment Elsana Aqifi, Raimonda Duka ANALYSIS AND RESULTS In the tables below we present the results of the analysis of this paper: Table 2 The Augmented Dickey- Fuller Test Time series P-value Augmented Dickey- Fuller Test Unemp 0,0215 Inf 0,0039 Growth 0,0162 Source: Author s calculations Above, we present the p-values of the Augmented Dickey-Fuller Test for each of our time series. Given a constant rejection of the null hypothesis at a default level of 5%, then we accept the alternative hypothesis (H1) that the series are stationary. So, we can proceed with the evaluation of the model by the traditional OLS method. In the table below we present the coefficients of the economic growth model estimated by the method of OLS (Ordinary Least Squares). The traditional method (OLS) is known in econometrics to assess the linear regression model. In practice, optimization by OLS method is performed by minimizing the sum of the squared errors of the model. OLS is a consistent assessor when regressors are exogenous and don t have multicolinearity. To have parameters estimated to mistakes should be homoskedastic (with constant variance) and uncorrelated to each other. An additional hypothesis is used and normal distribution of errors. 6

Journal of Business Paradigms Vol 1 No 1, 2016 Table 1 The results of regression model OLS Dep.variable: Unempl Estimate P-value CONSTANT 2,735 0,00837 Inf(t) -0,0431 0 Inf(t-1) -0,089 0,00845 Growth(t) -0,235 0,0179 Unempl(t-1) 0,812 0 F-statistic 344,45 0 R-Squared 0,6816 Adjusted R-Squared 0,6753 Source: Author s calculations In the table we assess the coefficient for each variable. The parameters are statistically valid. We reject the hypothesis that the model assessed is invalid because alpha is statistically equal to zero (less than 5%). The adjusted value of R square shows us that the estimated model explains about 67% of the variance of the dependent variable. Accordingly, the model is expressed in the form: r 2 = 0,6816 F=344,45 p=0.000 The model shows a significant negative relationship between unemployment and, as well as showing us the Philips curve, this also holds true for the Republic of Macedonia regarding the time period between 1998-2013. With a one percent increase in the inflation rate, unemployment decreased by 4.9%, thus supporting the trade-off between inflation and unemployment explained by the Philips's curve during this period. The model also shows that the unemployment lag has a very significant positive relationship with current unemployment. Nevertheless this can be suggestive of a lag in the results of fiscal policies that address the issue of unemployment and slow the expansion of private businesses that could 7

Impact Of Inflation On Unemployment Elsana Aqifi, Raimonda Duka have generated employment. Puzon (2009) posits that the significance of the unemployment lag may indicate that fiscal policies in relation to inflation may not have an immediate effect and that there could be policy lags. This highlights the impetus of urgently addressing the unemployment problem to slow down, if not curb, its increase. On the other hand, the survey results show the negative relationship between unemployment and economic growth; as our Okun's law significantly applies to the Republic of Macedonia. An adjusted R-Squared of 67% is associated with statistical significance, and shows that the model assumes a relatively good fit. An R2 of 68% indicates that only 32% of the variation in the unemployment rate cannot be explained by a change in any of the variables in the model. In the chart below, check whether or not the residuals follow the normal distribution. The adaptation to normal line distribution is generally good, we see some modest problems fitting in the extreme of a straight line. If the histogram is almost symmetrical about the value zero, then our model is not wrong on the average. Figure 1 Normal distribution of residuals Histogram of MBETJET Density 0.0 0.1 0.2 0.3 0.4 0.5-2 -1 0 1 2 3 MBETJET Normal Q-Q Plot Sample Quantiles -2-1 0 1 2-2 -1 0 1 2 Source: Author s calculations Theoretical Quantiles 8

Journal of Business Paradigms Vol 1 No 1, 2016 CONCLUSION Empirical analysis based on the OLS regression model of inflation and economic growth in unemployment gives us an estimate of the extent of their impact on the unemployment rate. The results show that these two independent variables have a significant effect on the dependent variable. Based on theoretical arguments, the linear regression model with two independent variables shows that the relation expressed in this model is statistically significant. The model shows that the negative relationship between unemployment and inflation as well as showing us the Philips curve, also holds true for the Republic of Macedonia regarding the time period from 1998-2013. With a one percent increase in the inflation rate, unemployment decreased by 4.9%, thus supporting the trade-off between inflation and unemployment explained for this period by the Philips's curve. A proper active labor market policy and effective implementation through multiple programs that provide training, qualification, counseling achievements, knowledge and skills required, can improve the current labor market, thus reducing the level of unemployment and thereby increasing employment in the labor market. It is also necessary to analyze and determine the optimal level of inflation rate that will not be detrimental to the economic development of this country. REFERENCES Aminu, U. and A.Z. Anono.: Effect of Inflation on the Growth and Development of the Nigerian Economy (An Empirical Analysis), International Journal of Business and Social Science. Vol.3 No.10, Special Issue- May 2012. Ball, Laurence, and Robert Moffitt.: Productivity Growth and the Phillips Curve, NBER Working Paper 8421, August 2001 Berentsen, A., Menzio, G. and Wright, R.: Inflation and unemployment in the long run, National Bureau of Economic Research, Working Paper Number 13924, 2008. Beyer, A., and Farmer, R. E.: Natural rate doubts. Journal of Economic Dynamics and Control 31 (3), 797 825, 2007. Brayton, et al.: What's Happened to the Phillips Curve?, Federal Reserve Board of Governors, June 1999. Chu, A., et al.: Money, random matching and endogenous growth: A quantitative analysis, MPRA Papers No. 48040, 2013. David A. Dickey and Wayne A. Fuller.: Distribution of the Estimators for Autoregressive Time Series With a Unit Root, Journal of the American Statistical Association, Vol. 74, No. 366, pp. 427-431, 1979. 9

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