Phillips Curve or Locus Critique: Time Series Evidence from Pakistan

Abstract

Some economic problems facing by any economy are addressed such that minimum levels of these are acceptable. Inflation and unemployment are among such macroeconomic issues of which certain minimum level of both are accepted by economists. Nature of relationship between unemployment and inflation is important in economic literature. This study was performed to find this nature for a developing country. Time series data on both variables was analyzed for Pakistan from 1974 to 2010. ADF test was applied for detection of non-stationary. Problem of non-stationary was detected when variables were at level, which was eliminated by taking variables at first difference. Johansen co-integration confirmed one cointegration vector, which suggested the presence of long run relation between variables. VECM was used to find short and long run estimates. A short run relation was witnessed when unemployment worked as dependent variable and inflation as explanatory variable. This model was in equilibrium and thirty five percent disequilibria were adjusted annually as ECT value suggested. Inflation had a significant positive association with unemployment in study period. This study supported the Locus critique as opposed to Phillips curve hypothesis. Policy makers should pay special attention to this relationship between inflation and unemployment when they are going to design macroeconomic policies for Pakistan’s economy.