Exchange-Rate Regimes, Political Parties and the Inflation-Unemployment Tradeoff: Evidence from Greece

We use Greek data during 1960–1994 to test and estimate a model in which wage inflation, price inflation and unemployment depend on the exchange rate regime, the identity of the political party in power and whether an election is expected to take place. We respect the Lucas critique and take into account the statistical properties of the data. The main results are: (i) The exchange rate regime matters for inflation. After the fall of the Bretton Woods regime in 1972, there is a Barro-Gordon type inflation bias due to the inability of all policymakers to precommit to low inflation. (ii) There are no Barro-Gordon type partisan differences in inflation or unemployment.

Open Economies Review (with Dong-Ho Lee and Apostolis Philippopoulos)

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Inflationary expectations, political parties and the exchange rate regime: Greece 1958-1989

We investigate the applicability of the ‘rational partisan’ and ‘exchange rate regime’ models of inflation to the case of Greece. Greece has fully participated in the Bretton Woods system of gxed exchange rates until 1972, but has since followed an independent ‘crawling peg’ policy. It has had a polarized political system and a problem of persistently high inflation in the last two decades. Outside fixed exchange rate regimes, persistently high inflation can be attributed to the failure of political parties to pre-commit to price stability. The higher aversion of ‘socialists’ to unemployment results in an inflation rate which is higher by 8 percentage points than under the more anti-inflationary ‘conservatives’. Unemployment is independent of the identity of the party in power and elections.

European Journal of Political Economy (with Apostolis Philippopoulos)

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On Error Correction Models: Specification, Interpretation, Estimation

Error Correction Models (ECMs) have proved a popular organising principle in applied econometrics, despite the lack of consensus as to exactly what constitutes their defining characteristic, and the rather limited role that has been given to economic theory by their proponents. This paper uses a historical survey of the evolution of ECMs to explain the alternative specifications and interpretations and proceeds to examine their implications for estimation. The various approaches are illustrated for wage equations by apphcation to UK labour market data 1855-1987. We demonstrate that error correction models impose strong and testable non-linear restrictions on dynamic econometric equations, and that they do not obviate the need for modelling the process of expectations formation. With the exception of a few special cases, both the non- linear restrictions and the modelling of expectations have been ignored by those who have treated ECMs as merely reparameterisations of dynamic linear regression models or vector autoregressions.

Journal of Economic Surveys (with Ron Smith)

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Tests of alternative wage employment bargaining models, with an application to the UK aggregate labour market

In this paper we propose a test that discriminates among alternative models of bargaining for wages and employment. The test rests on a theoretical framework which encompasses both the labour demand and the efficient bargain models of wage and employment determination. It is based on testing the cross equation restrictions implied for the coefftcients of union power variables in reduced form wage and employment equations. The test is illustrated for the Layard and Nickell model of the aggregate UK labour market, for which it is found that one can reject both the labour demand model and the hypothesis that wage employment bargains are efficient, in favour of a generalised model of inefficient bargaining for wages and employment.

European Economic Review (with Alan Manning)

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Traded Goods, Competitiveness and Aggregate Fluctuations in the United Kingdom

One important class of macroeconomic models comprises the two-sector models that emphasise the distinction between internationally traded and non-traded goods.  The literature utilising these models has been mainly theoretical, with the possible exception of the Scandinavian model of inflation. One reason for the lack of empirical work could have been the fact that categories such as ‘tradeables’ and ‘non-tradeables’ do not lend themselves to direct measurement. However, this should not stop us from drawing the macroeconomic implications of such models, and testing them using aggregate data. This paper puts a variant of such models to the test, using aggregate time series for the United Kingdom.  The model that is put forward treats the traded goods sector as fundamentally competitive, and the non-traded goods sector as oligopolistic. The focus is on the determination of the relative price of traded to non-traded goods, the equivalent of international competitiveness in these models, and its role in aggregate fluctuations. The model is ‘real’, and refers to the short run. Monetary factors have been de-emphasised. On the other hand, factors such as government expenditure, and the relative price of oil are given a prominent role. The econometric estimates suggest that at a general level the model is quite successful in accounting for the UK business cycle. At a ‘deeper’ level, however, the main problem is the implausibly low estimate of one crucial parameter, namely the share of tradeables in GDP. This takes a rather low value, especially in systems estimation. The point estimates of most of the other parameters are quite plausible and the overidentifying and cross-equations restrictions of the model are not rejected at conventional significance levels.

The Economic Journal

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On the Persistence of Unemployment

A comparison of unemployment across fourteen European countries, Japan and the US shows a great diversity of persistence: high in most of Europe outside the Scandinavian countries, Austria and Switzerland, low in Japan and the US.

Three reasons for unemployment persistence are examined. First, employed workers may not care about the unemployed, and only wish to protect their own jobs. The authors find little support for this view, except perhaps in the US. Second, workers may be reluctant to revise downward their wage aspirations. This seems to be the case in Europe, as opposed to the US and Japan. Third, firms may be slow in adjusting employment to its optimum level. This is the case in Europe and Japan, not in the US.

Labour market reforms might help, but have their own costs. The authors conclude that the best course of action is a demand expansion combined with incomes policies.

Economic Policy (with Alan Manning)

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Wage Setting and Unemployment Persistence in Europe, Japan and the USA

In this paper we set out to directly distinguish between insider membership dynamics and other sources of unemployment persistence. Our findings suggest that there are not sufficient differences in insider membership dynamics between the European economies and the United States. Thus, one cannot appeal to this source to justify the difference in their unemployment experience after the mid-seventies. This is in marked contrast to the conclusion of Blanchard and Summers. We suggest that their conclusions are sensitive to the way of approximating the natural rate of unemployment. Our second conclusion concerns sluggishness in labour demand. We find evidence of significant sluggishness in the three European economies and no sluggishness in the U.S.A. and Japan. This tentatively suggests that the persistence of European unemployment after the recent demand and supply shocks may have to do with this source.In section 2 we briefly present a version of the Blanchard and Summers model of wage and employment setting. In section 3 we modify and extend the model, and present estimates of the hysteresis coefficient, that measures the extent to which past employment determines the size of the group of insiders in wage negotiations. In section 4 we briefly investigate sluggishness in labour demand, and the conclusions are summed up in the final section.

European Economic Review (with Alan Manning)

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