Dynamics of Unemployment and Inflation

Dynamics of Unemployment and Inflation
An extended Phillips NAIRU model
Mohamed Rehan M S
Center of Excellence in Systems Science Indian Institute of Technology, Jodhpur 13th November 2013
Mohamed Rehan M S rehan@iitj.ac.in
The Phillips Curve

Historical inverse relationship between the rate of unemployment and the rate of inflation in an economy First observed by William Phillips Cornerstone for Keynesian Economic Policies
Trivia: Seven Nobel Prizes have been awarded for work critical of the Phillips curve!!!
The Phillips Curve
Phillips Curve today

Original model deemed to simplistic The relationship exists only in the short run Newer models have other factors included in them, most popular amongst them being Expectations Augmented Phillips Curves Imbibes concept of NAIRU (Non Accelerating Inflation Rate of Unemployment) a level of unemployment below which inflation rises
Comparison of various Phillips Curves
Mathematical Formulation
Multiple mathematical models for NAIRU Phillips Curves All models carry the two basic principles
Inflation is inversely proportional to Unemployment in the short run In the long run, monetary policy cannot affect unemployment
Derivation of our model

Ut+1 = Ut + i L Ut ot Ut
U i L o = = = = unemployment inflow rate of labor Labor force outflow rate of labor
ot =
Jt Ut +d (1Ut )
Jt = Jobs created at time t d = Fraction of currently employed people looking for better jobs
Mohamed Rehan M S rehan@iitj.ac.in Dynamics of Unemployment and Inflation
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Derivation of our model (contd.)

J t = J s + m t
m t = scaling factor = money growth rate in the market = Inflation rate at time t
Combining all three equations we get

Js + m t Ut+1 = Ut + i L Ut Ut = f(Ut , t ) Ut + d 1 Ut

t =
e t wb,t wp
1
1 (e t
wb,t wp wp
= expected rate of inflation = real bargained wage = real price determined wage
= price change factor
wp = 1 y wb,t = 1 1 b Ut y

e e = a + 1 a t t t+1 Substituting all previous equations we obtain 1 e (1 b)t t = (t + ) 1 and solving it for e t (1 b)t e t = t 1
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Finally, we obtain
t+1 1 = [ + at + 1 a 1 1 b Ut 1b t U ] 1 1 t+1
Which can be expressed as

t+1 1 = [ + at + 1 a 1 1 b Ut 1b t f(Ut , t )] 1 1
In other words, t+1 = g(Ut , t )
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Assumptions for Numerical Analysis

J s + m t Ut+1 = Ut + i L Ut Ut Ut + d 1 Ut t+1 1 = [ + at + 1 a 1 1 b Ut 1b t Ut+1 ] 1 1
a = 0.5 b = 0.5 d = 0.01 m = 0.03
= 0.04 = 2 = 0.5 L= 1
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Numerical Analysis
Fixed point obtained at (0.0224,0.03) Stability analysis for various values of i
i=0.12, =-0.8239,0.7356, stable i=0.16, =-1.4104,0.7395, unstable Stability lost at i=0.131992
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Bifurcation Diagram - Unemployment
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Bifurcation Diagram - Inflation
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Assumptions for analysis of systems

For analysis of chaotic nature, as well as sensitive dependence, we choose i = 0.18 For chaotic attractor diagram, initial point was chosen to be (0.1, 0.37), 50000 iterations
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Chaotic Attractor
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Chaotic Attractor (Contd.)

As t tends to infinity, any value is either
Eventually periodic to the fixed point, or Sucked into an orbit, which may be
Periodic (i=0.18, all periods possible) Chaotic Attractor
Out of 50000 iterations, not a single point is repeated, when it goes to a chaotic orbit!!!
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Sensitive Dependence
Sensitive dependence studied using two initial points (0.2,0.15) & (0.2,0.15+10-10) The points diverge from each other with time, implying that the system shows sensitive dependence on initial conditions As t tends to infinity, both points converge to entirely different orbits
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Sensitive Dependence (Contd.)
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Sensitive Dependence (Contd.)
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Basin of Attraction
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Conclusions
The NAIRU model exhibits chaotic behavior after a certain value of inflow of people to unemployment (approx. 0.18). Hence large layoffs, population bursts, heavy migration etc., can have serious impacts on the economy, and de-stabilize it by leading it to chaos Existence of chaotic orbits implies that there is no stable tradeoff
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Conclusions (Contd.)
The chaotic attractor resembles the original Phillips Curve with a negative slope However, the curve is composed of unstable disequilibria, and reaffirms that there is no feasible inflation-unemployment tradeoff Long periods of high inflation rates cannot occur. This should be kept in mind while designing monetary policy
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Future Prospects
Conduct analysis for different parameters, one by one. Conduct analysis for all parameters varying together and interacting with each other Instead of fixed values of various parameters, include their values from the actual time series. Try to develop a prediction technique for values in non-chaotic region Improve model with other exogenous inputs
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References
Day, Richard H. "Complex Economic Dynamics Vol. I. An introduction to dynamical systems and market mechanisms." (1994). Day, Richard Hollis. Complex economic dynamics: An introduction to Macroeconomic dynamics. Vol. 2. Vol. 2. Mit Press, 1999. Ferri, Piero, Edward Greenberg, and Richard H. Day. "The Phillips curve, regime switching, and the NAIRU." Journal of Economic Behavior & Organization 46, no. 1 (2001): 23-37. Neugart, Michael. "Complicated dynamics in a flow model of the labor market." Journal of Economic Behavior & Organization 53, no. 2 (2004): 193-213.
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QUESTIONS???
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THANK YOU!!
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Dynamics of Unemployment and Inflation

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Dynamics of Unemployment and Inflation

An extended Phillips NAIRU model

Mohamed Rehan M S rehan@iitj.ac.in