How Tennessee
Unemployment is Affected by Inflation
College of Business
Western Carolina University
Abstract
The unemployment rate in Tennessee is forecast to remain in the 3.3-3.8 percent range throughout the years 2000 and 2001. This forecast is based on the Industrial Production Index, past Tennessee unemployment rates, and the Michigan Inflation Expectation.
This paper forecasts the Tennessee unemployment rate for the years 2000 and 2001. The explanatory variable is the previous unemployment rates for Tennessee and the inflation rate, using the Michigan Inflation Expectation. This approach is based on the New Classical Model interpretation of the Phillips Curve. The Phillips Curve was used because of it asserts a short-run theoretical relationship between inflation and unemployment rates. It is important to have a forecast that will show the Tennessee unemployment rates for the next two years. Future inflation can be used to predict future unemployment rates, given static expectations.
The remainder of this paper provides data information, the economic theory used in forecasting the Tennessee unemployment, the actual results in the forecast, an evaluation on the importance of this forecast, and ending conclusions.
The first variable is the Tennessee unemployment rate. The rate is taken from the Federal Reserve Bank of St. Louis Economic Data (FRED). The rate used for the sample period was seasonally adjusted monthly rate for each month from 1978 to 1998. The second variable is inflation. The rate is computed from the Michigan University inflation study. The rate is seasonally adjusted in monthly data. The third variable is the Industrial Production Index. This number is used as a substitute for GDP. The forecast period is two years into the future. This data was used for two reasons: easy access of information and the credibility of the FRED database. Inflation and unemployment are important elements of the Phillips Curve; therefore they were necessary to complete the forecast.
This forecast assumes the Tennessee unemployment rate will change in proportion to the inflation rate. The Phillips Curve variables were used because of the relationship between inflation and unemployment rates and how they relate to one another. This means that unemployment is a function of inflation in the Phillips Curve:
u = f (i)
The combination of Tennessee unemployment, Industrial Product Index, and the University of Michigan Inflation Expansion are calculated in the equation of:
uf =f (ut-2, inft-2,Yt-2)
The Industrial Production Index was used as a proxy for real GDP because FRED gave real GDP based on a per year calculation, while the other variables in the data were reported in monthly variables. This made it possible for to calculate regression since all of the information is now in the form of monthly data.
The inflation rate was a very useful factor in calculating the relationship with unemployment. The equation used to calculate the unemployment rate of Tennessee in the years 2000 and 2001 is:
uf = a + (b*u f-2) + (c*INDPRO f-2) +
(d*inf f-2)
This forecast has a shortcoming because of the report of the inflation rate from the University of Michigan Inflation Expansion. This data is based on a survey of households and does not reflect the actual inflation rate for the years of 1978-1998. The inflation rate is based on expectations from households. Households look forward to what they think will be coming and base their actions on their perceptions. This means that households can over or under estimate the actual inflation rate. People decide what wages they will be willing to work for based on their expectations on the increase or decrease of inflation. This means that the forecast of unemployment for Tennessee may be skewed slightly.
In calculating the unemployment, the basic formula from above was used. The following data followed the same format. The calculation used to forecast unemployment in Tennessee is as follows:
uf = 2.44167 + (.416102*u f-2) + (-.018*INDPRO
f-2) + (.728159*inf f-2)
The forecast for unemployment in Tennessee is presented in table 1:
|
Table 1 Forecast Tennessee Unemployment January 2000 – December 2001 |
|
|
Date |
Forecast Unemployment
Rate |
|
Jan-00 |
3.63% |
|
Feb-00 |
3.67% |
|
Mar-00 |
3.73% |
|
Apr-00 |
3.61% |
|
May-00 |
3.70% |
|
Jun-00 |
3.71% |
|
Jul-00 |
3.64% |
|
Aug-00 |
3.50% |
|
Sep-00 |
3.42% |
|
Oct-00 |
3.55% |
|
Nov-00 |
3.41% |
|
Dec-00 |
3.56% |
|
Jan-01 |
3.74% |
|
Feb-01 |
3.67% |
|
Mar-01 |
3.76% |
|
Apr-01 |
3.67% |
|
May-01 |
3.61% |
|
Jun-01 |
3.09% |
|
Jul-01 |
3.35% |
|
Aug-01 |
3.50% |
|
Sep-01 |
3.38% |
|
Oct-01 |
3.55% |
|
Nov-01 |
3.58% |
|
Dec-01 |
3.69% |
This forecast projects the unemployment rate in Tennessee to remain around the 3.4 percent to the 3.7 percent for the years of 2000 and 2001. In looking at the Phillips Curve, the relationship between inflation and unemployment, the unemployment rate goes down as people expect an increase in inflation. In this forecast the Tennessee unemployment rate does not change drastically. This means people don’t expect inflation to increase.
In looking at the results of the forecast, the information is understandable. Unemployment has been at an all time low and there is no reason why expectations should change.. Since the unemployment rate and inflation rate are inversely related in the Phillips Curve in the short-run. The forecast implies that inflation will remain about the same.
In looking at this forecast, employers should have a moderate time in filling job vacancies. With the inflation rate, people looking into making large purchases should wait until the inflation rate decreases. This forecast can be used as a comparison for the neighboring states. This forecast can give insight into what is going on in that particular region and what to expect for the coming years.
This forecast does not assume any big changes or fluctuation in the next two years in regards to unemployment. This can also be said for the inflation rates. With there being a direct correlation between unemployment and inflation, it can be inferred that inflation rates will remain around the same. The government should be concerned with unemployment but not take any action. As it stands now, unemployment is at an all time low. The FED on the other hand, should raise inflation slightly. The natural unemployment rate is 6 percent and currently the unemployment rate is approximately 2 to 3 percent. With the raising of inflation, it will get unemployment back to the natural rate.
References
Federal Reserve Bank of St. Louis, Federal Reserve Economic Data (FRED), http://www.stls.frb.org/fred/.
Thomas, Lloyd B., Money, Banking, and Financial Markets New York: McGraw-Hill, 1997.