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N° 1998 - 07 |
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| August |
| Sacrifice Ratios in Europe : a Comparison |
Laurence Boone
Benoît Mojon |
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Inflation seems now well below 3% almost
everywhere in Europe and has been so for a number of years in a number of EU countries.
At the same time, unemployment has steadily risen, and seems now stabilised at
records high level. Even if the Phillips curve is vertical in the long term, this
observation yields questions about the short to medium term impact of the disinflationary
policies implemented throughout the eighties and the nineties. Could they partly
explain the level and the persistence of the European unemployment rates?
The European System of Central Bank’s main objective is to control inflation. This objective may be achieved through slowing final demand which at least in the short-run, would imply rising unemployment. An important body of literature provides evidence on structural differences in European labour markets. It can be expected that these latter will be reflected by differences in the way monetary policy is transmitted through the labour market. If that is the case, the costs of disinflationary policies, in terms of unemployment, is likely to vary across European countries.
The aim of this paper is twofold. First, we try to assess to what extent the transmission mechanisms are different across Europe. We concentrate on Europe’s four biggest economies: France, Germany, Italy and UK. Second, we seek to evaluate whether the building of Europe (through the Single Market implementation and the run-up to EMU) has triggered a process of convergence among European countries.
The econometric methodology takes its root in the ‘revisionist history of the Phillips curve’ of King and Watson (1994). The idea is that, although there is no long-run trade-off between inflation and unemployment
(i.e these two I(1) series are not cointegrated), there might exist a relationship in the short to medium run, due to adjustment lags and labour market rigidities. We build up a bivariate VAR for inflation and unemployment, in which a demand shock is defined as a shock which moves the two series in opposite direction. The VAR impulse response function then allow the persistence effect of shocks onto inflation and unemployment to be computed, from which we derive an assessment of the degree of symmetry in the transmission of monetary policy through the labour market in Europe.
We shall see that quite restrictive assumptions are required for the sacrifice ratios to be of similar magnitude across countries. Furthermore, we cannot provide evidence of a structural convergence process in Europe. Finally, we show that the sacrifice ratios have been rising since the mid-eighties for the four countries we study, which means that the cost of disinflationary policies is higher today (when the inflation rate is already low) than it used to be. This suggests that the short-run inflation-unemployment trade-off is non linear with respect to inflation. |
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