Modern Model of Interconnection of Inflation and Unemployment in Latvia


  • Yuri Kochetkov Baltic International Academy



unemployment, inflation, econometric model, correlation, regression


Globalisation contributes to stabilisation of monetary policy of countries, achievement of price stability and decrease rates of inflation. There is no clear generally accepted concept for “inflation”. A number of experts consider inflation to be a complicated multisided process, which depends not only on economical but also on social and political reasons. One of the main aims of state governments and central banks of the majority of world countries is the decrease of inflation due to its negative effect on the economy. Researches have shown that in developed countries inflation higher than 3% leads to substantial slowdown of economy growth rate. A. Phillips determined the presence of negative correlation between the rate of inflation and the rate of unemployment. On the basis of so called Phillips curve a wrong conclusion was done that by increasing inflation it is possible to decrease unemployment. It wasn't confirmed in practice. There is a hypothesis stating that unemployment has a certain “natural” Not Accelerating Inflation Rate of Unemployment (NAIRU). Nowadays Phillips curve (1958) is considered in a wider sense as a complicated event, developing in the absence of neutrality of money in economic processes. The object of the research is interconnection of inflation and unemployment in Latvia. The goal of the research – analysis of interconnection between inflation and unemployment in Latvia, estimation of the “natural” rate of unemployment. All these researches have not been done before. By using the statistical data of Latvia and analysis thereof show the possibility of using modern mathematical regression models for researches of macroeconomic indicators. Methods of the research are mathematical modelling, correlation and regression analysis.

In Latvia systematic accounting of unemployment is done from 1996. For analysis of the interconnection between time series of inflation rate and unemployment a non-linear regression equation - a quadratic parabola was computed and estimated. The considered period is from the year 1996 until 2008. The negative correlation between inflation and unemployment occurs within the whole considered time length. Classical Phillips curve is missing. However, within the period from the year 1999 until 2008 negative correlation occurs, as it is with Phillips curve. Such change of correlation between inflation and unemployment from positive to negative value at the turn of 1998-99 is obviously explained by macroeconomic changes and development peculiarities in Latvia. To identify peculiarities of inflation in Latvia the period from 1999 to 2008 has been analysed separately. To check the quality of the regression models the correlation and regression analysis was done. The calculated index and coefficient of determination in both cases point at quite good quality of regression models: with the help thereof it is possible to explain 70 % and 60 % of inflation respectively.  It is possible to say that both models of regression adequately fit empirical data and are appropriate for use. As long as analysis of dynamics time series is fulfilled, a check has been done for the presence of autocorrelation in residuals, which is subjected to autoregressive process of the first order. For the check of the main hypothesis Но : ρ = 0 Durbin-Watson test statistics has been used. Analysis showed that in these models there is no autocorrelation, econometric models can be used for analyses. A multiple linear equation of inflation autoregression model was obtained and analysed also.  To determine the “natural” rate of unemployment in Latvia (NAIRU) the last equation is changed. As a result it is obtained that the estimate of the “natural” rate of unemployment for Latvia's economy is quite large 16%. In developed market economies NAIRU is much less. This denotes existence of disproportions and drawbacks of macroeconomic development. This is confirmed by very adverse consequences of the financial and economic crisis for Latvia. A number of macroeconomic experts believe that Latvia needs an "industrial revolution": accent on development of the priority branches of industry, export. Changes in the structure of government, education, as well as creation of attractive environment for investments are necessary also. The analysis of interconnection between  inflation and unemployment in Latvia, which was done according to mathematical regression models quite sufficiently corresponding to empirical data, points to the possibility of successful application of such models for analysis and researches of macroeconomic indicators.


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