Inflation, unemployment, and labour force. Phillips curves and long-term projections for Austria

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Abstract

We model the rate of inflation and unemployment in Austria since the early 1960s within the Phillips/Fisher framework. The change in labour force is the driving force representing economic activity in the Phillips curve. For Austria, this macroeconomic variable was first tested as a predictor of inflation and unemployment in 2005 with the involved time series ended in 2003. Here we extend all series by nine new readings available since 2003 and re-estimate the previously estimated relationships between inflation, unemployment, and labour force. As before, a structural break is allowed in these relationships, which is related to numerous changes in definitions in the 1980s. The break year is estimated together with other model parameters by the Boundary Element Method with the LSQ fitting between observed and predicted integral curves. The precision of inflation prediction, as described by the root-mean-square (forecasting) error is by 20% to 70% better than that estimated by AR(1) model. The estimates of model forecasting error are available for those time series where the change in labour force leads by one (the GDP deflator) or two (CPI) years. For the whole period between 1965 and 2012 as well as for the intervals before and after the structural break (1986 for all inflation models) separately, our model is superior to the naïve forecasting, which in turn, is not worse than any other forecasting model. The level of statistical reliability and the predictive power of the link between inflation and labour force imply that the National Bank of Austria does not control inflation and unemployment beyond revisions to definitions. The labour force projection provided by Statistic Austria allows foreseeing inflation at a forty-year horizon: the rate of CPI inflation will hover around 1.3% and the GDP deflator will likely sink below zero between 2018 and 2034.