Kiel Working Papers, Kiel Institute for World Economics
No 1501:
Inflation and Unemployment in the Long Run
Aleksander Berentsen, Guido Menzio and Randall Wright
Abstract: We study the long-run relation between money, measured by
inflation or interest rates, and unemployment. We first discuss data,
documenting a strong positive relation between the variables at low
frequencies. We then develop a framework where both money and unemployment
are modeled using explicit microfoundations, integrating and extending
recent work in macro and monetary economics, and providing a unified theory
to analyze labor and goods markets. We calibrate the model, to ask how
monetary factors account quantitatively for low-frequency labor market
behavior. The answer depends on two key parameters: the elasticity of money
demand, which translates monetary policy to real balances and profits; and
the value of leisure, which affects the transmission from profits to entry
and employment. For conservative parameterizations, money accounts for some
but not that much of trend unemployment -- by one measure, about 1/5 of the
increase during the stagflation episode of the 70s can be explained by
monetary policy alone. For less conservative but still reasonable
parameters, money accounts for almost all low-frequency movement in
unemployment over the last half century
JEL-Codes: E24,; E52; (follow links to similar papers)
76 pages, March 2009
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