Original paper:

Kitov, I., (2007). Exact prediction of inflation and unemployment in Germany, MPRA Paper 5088, University Library of Munich, Germany, http://ideas.repec.org/p/pra/mprapa/5088.html

On July 1, we presented a model of the evolution of unemployment in Germany developed in [1]. There were new readings of unemployment (from 2005 to 2007) and labor force (from 2004 to 2006) available at the OECD , and we were able to verify the model, to extend it in time, and to predict beyond 2009.

The model stats, that unemployment in developed countries is a function of labor force change [2-5]. There is a general expectation of a good fit between these two variables for Germany. Figure 1 repeats the results of a simple manual trial-and-error process for the period between 1965 and 2007. Since such procedure is based on visual fit only, no statistical estimates of the residual were made.

The resulting relationship between unemployment and labor force in Germany is as follows:

The model stats, that unemployment in developed countries is a function of labor force change [2-5]. There is a general expectation of a good fit between these two variables for Germany. Figure 1 repeats the results of a simple manual trial-and-error process for the period between 1965 and 2007. Since such procedure is based on visual fit only, no statistical estimates of the residual were made.

The resulting relationship between unemployment and labor force in Germany is as follows:

UE(t) = 2.5*dLF(t-5)/LF(t-5) + 0.04, before 1995

UE(t) = 2.5*dLF(t-5)/LF(t-5) + 0.08, after 1995 (1)

UE(t) = 2.5*dLF(t-5)/LF(t-5) + 0.08, after 1995 (1)

where UE(t) is the rate of unemployment in Germany at time t, LF(t-5)is the level of labor force five years earlier. The observed unemployment needs a structural break to be introduced in 1995, which is easily explained by the reunification, i.e. 1990 plus the five-year lag. Free term in (1) underwent a significant increase, but the slope of 2.5 and the time lag of 5 years did not change, however. (It should be noted that the slope depends of definition of unemployment and labor force, i.e. on reporting agency.) One can read (1) in the following way – a 1% increase in labor force in Germany results in 2.5 % increase in unemployment five years later. When the labor force does not change, the level of unemployment is constant at 8%.

An important finding here is that unemployment in Germany increases with increasing rate of labor force growth. So, the remedy against high unemployment in Germany consists in the (likely artificial) reduction of labor force growth. The estimates of unemployment are provided by the OECD and cover the period till 2007. In 2008, the unemployment had to reach the bottom around 8% (notice that this prediction was made in 2004!). In 2009, the rate of unemployment in Germany should be increasing due to the increase in labor force five years ago, not due to the crisis. In 2010, it will reach its peak value at 11% and then will start to decline into the 2010s.

Figure 1. Observed and predicted rate of unemployment in Germany.

In order to test our model, we have borrowed unemployment estimates from the DEStatics (Federal Statistics Office). They are slightly different from those provided by the OECD, and are issued at monthly frequency. Figure 2 presents the measured and predicted unemployment rate for the period between 2000 and 2012. The predicted curve has slightly higher coefficient than that obtained from the OECD data (+3.2):

In order to test our model, we have borrowed unemployment estimates from the DEStatics (Federal Statistics Office). They are slightly different from those provided by the OECD, and are issued at monthly frequency. Figure 2 presents the measured and predicted unemployment rate for the period between 2000 and 2012. The predicted curve has slightly higher coefficient than that obtained from the OECD data (+3.2):

UE(t) = 3.2*dLF(t-5)/LF(t-5) + 0.08 (2),

but the time shift is the same – five years. All in all, both curves are very close. Therefore, our prediction of 11% rate in 2011 is a reliable one. Germany will suffer another surge in unemployment rate during the next 18 months. In 2010 the rate will reach 9%.

Figure 2. Observed and predicted rate of unemployment in Germany - likely to reach 11% in 2011.

**References**[1] Kitov, I., (2007). Exact prediction of inflation and unemployment in Germany, MPRA Paper 5088, University Library of Munich, Germany, http://ideas.repec.org/p/pra/mprapa/5088.html

[2] Kitov, I., Kitov, O., Dolinskaya, S., (2007). Inflation as a function of labor force change rate: cointegration test for the USA, MPRA Paper 2734, University Library of Munich, Germany, ideas.repec.org/p/pra/mprapa/2734.html

[3] Kitov, I., (2007). Inflation, Unemployment, Labor Force Change in European countries, in T. Nagakawa (Ed.), Business Fluctuations and Cycles, pp. 67-112, Hauppauge NY: Nova Science Publishers

[4] Kitov, I., (2007). Exact prediction of inflation and unemployment in Canada, MPRA Paper 5015, University Library of Munich, Germany, http://ideas.repec.org/p/pra/mprapa/5015.html

[5] Kitov, I., Kitov, O., (2009). Unemployment and inflation in Western Europe: solution by the boundary element method, MPRA Paper 14341, University Library of Munich, Germany

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