Unemployment

There is a principal assumption of the existence of a tight link between inflation and unemployment known as the Phillips curve. The concept of the Phillips curve serves as a basis for many macroeconomic models and business cycle theories. There is no "completely satisfactory explanation" [Mankiw, 2000] of this virtual tradeoff, however. Existing models meet severe problems to explain some outstanding features of the presumed tradeoff between inflation and unemployment, such as, for example, stagflation and disinflation accompanying decreasing unemployment, without using some exotic exogenous forces or shocks. This lack of proof or demonstration of even a weak empirical confirmation of the relationship does not prevent "central bankers and monetary economists" [Mankiw, 2000] from adhering to its usage in practice. Hence, any clear explanation of the existence of tradeoff between inflation and unemployment, or its absence, in which case the bankers, monetary policy-makers and economists are wrong in their unproven assumption, is of great value. We show below that there is no tradeoff between unemployment and inflation. Fortunately, the period between 1990 and 2010 is characterized by just minor changes of the studied variables. This is what makes current policy so "successful". There are some challenges arising in near future, however.

In the first section, we argue that the presumed relationship between inflation and unemployment is just a simple lagged linear function with a positive coefficient. This effectively means that, if accordingly modified, the Phillips curve is an upward-sloping function with a coefficient close to one, but where unemployment does not affect inflation.

If unemployment in the USA is a lagged linear function of inflation, it is important to find the potential forces driving the inflation itself. The macroeconomic model developed by Kitov [2005a,b] provides a consistent framework for such an analysis. The two principal findings of the model are as follows: 1) real economic growth in the USA depends only on the attained value of real GDP per capita and the relative change in the number of nine-year-olds in the population; 2) the personal income distribution (PID) is very rigid relative to real economic growth and inflation. The first finding allows effective decoupling of the study of inflation from the economic development - the real economic growth in terms of GDP per capita does not depend on inflation and vice versa. The second finding leads to a simple idea that inflation causes only nominal income changes but not relative changes in distribution of income, i.e. a given portion of population always has a predefined portion of the total GDP. Thus, any successful personal attempt to occupy a position with a larger income that is already occupied causes some forces directed to return the person to her/his original relative position, i.e. stretching the PID and inducing inflation. (One can imagine a climb by a downward running escalator - all efforts to climb up result in the same position relative to the ground but changing relative to the escalator itself. Similarly, persons enjoy a higher nominal income but the same relative place in the PID.)

Labor force change is a potential candidate for describing the process of personal attempts to advance in the PID. The second section describes the process and provides empirical facts supporting this concept. One of the findings is that the labor force change leads inflation by three years. Therefore, this causality principle excludes the current inflation value from being controlled by some contemporary means including monetary ones. One cannot exclude "insane" behavior of some monetary authorities, however, such as flooding an economy with money. This is not the case for the USA, but it happens sometimes in countries in transition. In our opinion, the driving force for such "strange" behavior is the redistribution of personal incomes in a new way after failure of the old economic and social organization. One can observe a fast evolution of PID in former socialist countries during the last 15 years from a truncated "socialist" version to a wide "capitalist" one.

Having in the first two sections demonstrated causal relationships between unemployment and inflation and between inflation and labor force change, one can easily apply the same methodology to the dependence of unemployment on labor force. The third section provides some details of this analysis and shows that the observed unemployment in the USA is a lagged linear function of labor force change and inflation. Thus one can consider unemployment to be a result of those who tried to enter the PID at higher incomes but who induced inflation. It consists of people who have failed to change their income positions and correspondingly increased inflation. All migrationary processes inside the PID have their characteristic times inducing observed delays between the acting forces and outcomes. These processes are out of the scope of the study and present a challenge to future investigation.

We also discuss briefly some potential outcomes and some directions for the future study and application. We insist that modern business cycle theories should be rejected as inappropriate and more efforts should be applied to study the processes responsible for the propagation of labor force changes through the real economy. Economics should advance to studying real processes, not artificial mathematic assumptions and "stylized" facts. Economics needs to cross from the realm of astrology to the realm of astronomy. The former may be more exciting, but the latter is more practical and can be tested and validated.

1. Unemployment and inflation

A standard way of presenting the relationship between inflation (INF) and unemployment (UE) is a scatter plot of simultaneous measurements. Unemployment is measured by the US Census Bureau (CB) during the Current Population Survey (CPS) [CB, 2002] and is published monthly by the Bureau of Labor Statistics (BLS) [BLS, 2005a]. Unemployment is not an accurately measured variable as described by the CB.

Inflation is an even more obscure variable. There are numerous definitions of inflation resulting in different values. The principal problem for any of these definitions is the estimation of the price of new products. In the world of goods and services renewed at accelerating rate, there is no reliable procedure to estimate the price change for new goods even if they are substitutes for some old goods. Thus, the concept of inflation and hence the concept of real economic growth is partly artificial and bears a flavor of subjective judgment. All these problems make the finding of any strict relationship between the variables not only difficult but also a