Inflation and Unemployment in Germany

Exact prediction of inflation and unemployment in Germany
Ivan O. Kitov

Abstract
Potential links between inflation, π(t), and unemployment, UE(t), in Germany have been examined. There exists a consistent (conventional) Phillips curve despite some changes in monetary policy. This Phillips curve is characterized by a negative relation between inflation and unemployment with the latter leading the former by one year: UE(t-1) = -1.50π(t) + 0.116. Effectively, growing unemployment has resulted in decreasing inflation since 1971, i.e. for the period where GDP deflator observations are available. The relation between inflation and unemployment is statistically reliable with R2=0.86, where unemployment spans the range from 0.01 to 0.12 and inflation, as represented by GDP deflator, varies from -0.01 to 0.07.
A linear and lagged relationship between inflation, unemployment and labor force has been also obtained for Germany. Changes in labor force level are leading unemployment and inflation by five and six year, respectively. Therefore this generalized relationship provides a natural prediction of inflation at a sixyear horizon, as based upon current estimates of labor force level. The goodness-of-fit for the relationship is 0.87 for the period between 1971 and 2006, i.e. including the periods of high inflation and disinflation.
Key words: inflation, unemployment, labor force, prediction, Germany
JEL Classification: E3, E6, J21

Introduction
This paper is a continuation of a series devoted to the change rate of labor force level as the driving force behind inflation and unemployment (Kitov, 2006abc; Kitov, 2007ab;
Kitov, Kitov, Dolinskaya, 2007ab). The principal finding of our previous studies conducted for the USA, Japan, France, Austria and Canada consists in the existence of a linear and lagged link between labor force, inflation and unemployment. In some countries, this generalized link can be separated into two independent linear links
between

References: Bureau of Labor Statistic, (2007). Foreign Labor Statistic. Table, retrieved at 20.07.2007 from http://data.bls.gov/PDQ/outside.jsp?survey=in Doepke, J., Dovern, J., Fritsche, U., Slacalek, J., (2005). European inflation expectations dynamics, Deutsche Bundesbank, Discussion Paper, Series 1: Economic Studies, No 37/2005 Gottschalk J., Fritsche, U., (2006) Vertical Phillips Curve: Does it hold for Germany? DEP Discussion Papers, Macroeconomics and Finance Series, 1/2006, Hamburg, 2006 Hayo, B., Hofmann, B., (2005). Comparing Monetary Policy Reaction Functions: ECB versus Bundesbank, Marburg Papers on Economics, No Working Papers 28, ECINEQ, Society for the Study of Economic Inequality Kitov, I., (2006b) University Library of Munich, Germany Kitov, I., (2006c) of Munich, Germany Kitov, I., (2007a) Kitov, I., (2007b). Exact Prediction of Inflation and Unemployment in Canada. (in preparation), MPRA Paper 2735, University Library of Munich, Germany Kitov, I., Kitov, O., Dolinskaya, S., (2007a). Relationship between inflation, unemployment and labor force change rate in France: cointegration test, MPRA Paper Kitov, I., Kitov, O., Dolinskaya, S., (2007b). Inflation as a function of labor force change rate: cointegration test for the USA, MPRA Paper 2734, University Library of Mankiw, N.G. (2000). The Inexorable and Mysterious Tradeoff Between Inflation and Unemployment, Harvard Institute of Economic Research Working Papers Nelson, E., (2006). The Great Inflation and Early Disinflation in Japan and Germany, Federal Reserve Bank of St http://research.stlouisfed.org/wp/2006/2006-052.pdf OECD, (2005)