Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/103154
Authors: 
Fritsche, Ulrich
Gottschalk, Jan
Year of Publication: 
2006
Series/Report no.: 
DEP (Socioeconomics) Discussion Papers, Macroeconomics and Finance Series 1/2006
Abstract: 
New-Keynesian macroeconomic models typically assume that any long-run trade-off between inflation and unemployment is ruled out. While this appears to be a reasonable characterization of the US economy, it is less clear that the natural rate hypothesis necessarily holds in a European country like Germany where hysteretic effects may invalidate it. Inspired by the framework developed by Farmer (2000) and Beyer and Farmer (2002), we investigate the long-run relationships between the interest rate, unemployment and inflation in West Germany from the early 1960s up to 2004 using a multivariate co-integration analysis technique. The results point to a structural break in the late 1970s. In the later time period we find for west Germany data a strong negative correlation between the trend components of inflation and unemployment. We show that this finding contradicts the natural rate hypothesis, introduce a version of the New Keynesian model which allows for some hysteresis and compare the effectiveness of monetary policy in these two models. In general, a policy rule with an aggressive response to a rise in unemployment performs better in a model with hysteretic characteristics than in a model without.
Subjects: 
Cointegration
Vector error Correction Model
Unemployment
Phillips Curve
Hysteresis
JEL: 
B22
C32
E24
Document Type: 
Working Paper

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