FACTORS THAT AFFECTS THE CHANGES OF INFLATION IN THE US DURING THE PERIOD OF 1966 – 2012 PDF

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FOREIGN TRADE UNIVERSITYFACULITY OF INTERNATIONAL ECONOMICS---------***---------MID-TERM ECONOMETRICS REPORTTOPICFACTORS THAT AFFECTS THE CHANGES OF INFLATIONIN THE US DURING THE PERIOD OF 1966 – 2012INSTRUCTOR : Dr. Chu Th ị Mai PhươngDr. Vũ Thị Phương Mai CLASS : KTEE310 (2/2021). MEMBER : Hoàng N...

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FOREIGN TRADE UNIVERSITY FACULITY OF INTERNATIONAL ECONOMICS ---------***---------

MID-TERM ECONOMETRICS REPORT

TOPIC FACTORS THAT AFFECTS THE CHANGES OF INFLATION IN THE US DURING THE PERIOD OF 1966 – 2012

INSTRUCTOR :

Dr. Chu Thị Mai Phương Dr. Vũ Thị Phương Mai

CLASS

:

KTEE310 (2.1/2021).1

MEMBER

:

Hoàng Ngọc Anh – 1913340005 Nguyễn Đức Cường – 1913340012 Vũ Trường Sơn – 1913340034

Hanoi, December 2020 1

Table of Contents 1

THEOREOTICAL BASIS OF THE RESEARCH TOPIC .......................................................... 3 1.1 1.1.1 1.1.2 1.1.3

1.2

The relationship between inflation, wages and unemployment. ..................................... 3 In short-term ..................................................................................................................................... 3 Long term .......................................................................................................................................... 4 Conclusion ......................................................................................................................................... 5

The relationship between inflation and CPI .................................................................... 6

2 MODEL SPECIFICATION TESTING THE INFLUENCE OF UNEMPLOYMENT, CPI, AVERAGE WEEKY EARNINGS ON INFLATION OF UNITED STATE DURING 1966-2012 ........................... 7 2.1 2.1.1 2.1.2

Method to derive the model ............................................................................................................ 7 Method to collect and analyze the data ........................................................................................... 7

2.2

Population Regression Model ........................................................................................ 8

2.3

Explanation of variables ................................................................................................ 8

2.4

Description of the data ................................................................................................ 10

2.4.1 2.4.2 2.4.3

3

Methodology in the study ............................................................................................. 7

Data sources ................................................................................................................................... 10 Statistical description of the variables ............................................................................................ 10 Correlation matrix between variables ............................................................................................ 11

ESTIMATED MODEL AND STATISTICAL INFERENCE .................................................... 13 3.1

Estimated model and estimated result......................................................................... 13

3.2

Testing the level of relevance of the model .................................................................. 14

3.3

Testing the hypothetical violations .............................................................................. 15

3.3.1 3.3.2 3.3.3 3.3.4 3.3.5

3.4 3.4.1 3.4.2 3.4.3

3.5 3.5.1 3.5.2

Testing Omit variable Ramsey Reset .............................................................................................. 15 Testing Multicollinearity ................................................................................................................. 15 Heteroscedasticity .......................................................................................................................... 17 Testing autocorrelation .................................................................................................................. 17 Testing normality of residual .......................................................................................................... 19

Testing an individual regression coefficient .................................................................. 20 Testing the CPI ................................................................................................................................ 20 Testing the UNEMP ......................................................................................................................... 20 Testing the WGGR ........................................................................................................................... 20

Final result and Discussion ........................................................................................... 22 Final regression model .................................................................................................................... 22 Discussion ....................................................................................................................................... 22

4

CONCLUSION AND POLICY IMPLICATION .................................................................. 24

5

REFERENCES ............................................................................................................ 25

2

ABSTRACT In recent years, on social media, there has been a country that are “famous for” the word Inflation – Venezuela. From one of the wealthiest country on earth, with inflation, Venezuela is immersed in poverty, violence and illness. So is inflation really a problem for the economy? According to economists and the prestigious website Investopedia.com, Inflation is the decline of purchasing power of a given currency over time. More specifically, a quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. We need to clearly understand that the increase of the average price level here is the general increase of goods and services, not just a particular kind of good. When the value of goods increases, it means that the purchasing power of money decline. So that with the same amount of money, customers now can buy less than before. Moreover, in case of relationship with other economies, inflation can be defined as the devaluation of a currency compared to others. However, the devaluation of the money doesn’t always mean that inflation has negative impacts on the economy. Otherwise, the negative influences of inflation only occur when the governments are unable to control the increase intensity of it. In this case, when inflation is not measured and adjusted, it can lead to many negative impacts on the national economy and even affect other economies. For example: trade balance instability, push costs, shoe-leather costs or hoarding wealth. Conversely, if inflation is only moderate, it will cause the labor market to reach equilibrium faster, ensuring discount rates and rediscounts in the money and money markets. main. At the same time, moderate inflation also helps goods and services markets avoid the jagged pattern of price fluctuations.

In fact, in addition to the above three factors, there are also many factors affecting the inflation rate (based on Consumer price index - CPI). According to Keynes, besides the Consumer price index - CPI, cost-push or adaptive expectation are also two factors 1

leading to inflation. As for push costs, it can be simply understood that: When a government cuts taxes or increases recurrent consumption spending, budget deficits and currency devaluation that incur inflation taxes will increase the cost of raw materials. Then, the increasing cost of raw materials leads to the bankruptcy of businesses, reducing total supply (potential output). Along with adaptive expectations, inflation is understood as the inherent state of the economy. If workers try to keep their wages at the price (above the inflation rate), firms will pass on this higher cost of labor to the customer - through an increase in the prices of goods and services. This leads to a loop of repeating, causing inflation.

However, when building the model, we find that three factors: Consumer price index, Unemployment rate, and Percent change in average weekly earnings greatly affect the changes of inflation rate. According to William Philips, there is an inverse relationship between the unemployment rate and inflation, through the intermediate factor is the level of food. That means if the unemployment rate is low, the economy must create more jobs, businesses expand production and total output increases. That also means accepting high inflation and vice versa. Therefore, we choose inflation and the factors affecting inflation (Consumer price index - CPI, Unemployment rate, Percent change in average weekly earnings) as the topic for our econometrics report.

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1

THEOREOTICAL BASIS OF THE RESEARCH TOPIC

1.1 The relationship between inflation, wages and unemployment. The relationship between these three quantities is a two-way relationship and the study focuses on the effects of wages on inflation and unemployment. The author admits that it is impossible to have a perfect relationship between two quantities (one quantity is only affected by the other and vice versa). There are many factors other than wages that influence inflation but certainly the rate of change in wages has a strong effect on inflation. In addition, the author does not deny the impact of unemployment on inflation, but it is a two-way relationship and both are affected by many other factors.

1.1.1 In short-term

A.W.Phillips was one of the first economists to seek to demonstrate a negative correlation between inflation and unemployment. Philips has studied extensively on the relationship between the inflation rate and the UK unemployment rate for almost a century (from 1861 to 1957). Eventually he discovered that there was a trade-off between the two. The trade-off of unemployment for wages His assumption is that the demand for resources increases, labor becomes scarce, businesses will quickly offer higher wages to attract workers. However, when the demand for resources decreases and unemployment increases, workers will be reluctant to accept a salary lower than what they deserve. So the rate of wage growth will gradually decrease. The trade-off of wages to unemployment The second problem that affects the change in wage growth rate is the change in the unemployment rate. When the economy thrives, businesses reap great profits, they are willing to pay generous wages in hiring labor. This greatly increases the labor supply, 3

and the unemployment rate then dropped rapidly. On the contrary, when the business is not doing well, the salary of employees does not increase or increase very slowly, the demand for labor decreases, the unemployment rate becomes highly The above assumption by Phillips describes a non-linear relationship between unemployment and wage inflation. The curves that form the relationship between the unemployment rate and the overall rate of price inflation (or rather wage inflation) have made the Phillips curve famous. The wage inflation data Phillips uses can also be descriptive for general price inflation. Because wages are also year in the production costs of the business. Raising wages will result in the price of goods and services, and this is also the most basic definition of inflation. 1.1.2 Long term

In the late 1960s, a group of economists representing the money major, typically Milton Friedman and Edmund Phelps, gave sharp analysis and criticism that the Phillips curve could not be applied in the long run. term. In the long run, unemployment will return. The natural adjustment mechanism of the market will return unemployment, this period is called by Paul Samuelson in the period of stagflation. In the short term, wage increases will attract more workers. At this point, the supply of labor will become plentiful, leading to the unemployment rate starting to decline. However, workers will gradually find that their wage purchasing power is reduced due to inflation, and they will offer a higher salary to keep wages up to date. The supply of labor thus began to narrow while wage inflation and general price inflation continued to rise, or even faster than before. Increasing inflation to reduce unemployment is, in the long run, not conducive to the economy. Similarly, reducing the inflation rate does not cause the unemployment rate to rise. Since inflation does not affect the long-run unemployment rate, the Phillips curve becomes a vertical line when it intersects the horizontal axis at the value of the natural unemployment rate.

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1.1.3 Conclusion

The negative correlation between inflation and unemployment in the Phillips curve can only describe the economy in the short run, especially when the inflation rate is in a steady state. It cannot be applied in the long run, because the market mechanism will adjust the unemployment rate to its natural rate. The Phillips curve is not a key for the economy, nor can it be applied to “fight against” the unemployment of a country, it can even do harm to the economy.

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1.2 The relationship between inflation and CPI

Economists often use two indicators to evaluate the inflation rate of the economy: the consumer price index CPI and the total domestic product deflator. Here, the CPI represents the fluctuation of a general price level for a basket of consumer endconsumption goods and services. However, according to Investopedia, CPI is not a perfect indicator to measure inflation because of the following factors: • The quality of goods increases, the price also increases, but the CPI sees that increase as inflation • The appearance of new goods makes it difficult to compare with old substitutes • Consumers have many alternatives to where they will buy, but the CPI surveys do not take these into account.

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2 MODEL SPECIFICATION TESTING THE INFLUENCE OF UNEMPLOYMENT, CPI, AVERAGE WEEKY EARNINGS ON INFLATION OF UNITED STATE DURING 1966-2012

2.1 Methodology in the study

2.1.1 Method to derive the model The process using in the research is called Multiple Linear Regression. This is a linear approach to modeling the statistical relatonship of a dependent variable on one or more explanatory variables.

2.1.2 Method to collect and analyze the data

2.1.2.1 Collect the data

Collected data are secondary data, in form of Time Series, showing the numerical information of some factors of United State in 47 years from 1966 to 2012. The data was collected base on the data set 2-3 of the book “Introductory Econometrics With Applications by Ramanathan” from the source Economic Report of the President 1995 and 2012 govinfo.gov, which has a very high level of accuracy.

2.1.2.2 Analyze the data

Our group has used Stata to analyze the dataset and interpret the correlation matrix between variables

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INFL= f(CPI, UNEMP, WGGR) Where: • INFL: Percent change in CPI (inflation rate) • CPI: Consumer Price Index • UNEMP: Civilian unemployment rate (%) • WGGR: Percent change in average weekly earnings, in current dollars

Thus, according to the economic theories, in order to analyze the factors influencing the Inflation rate, our group has discussed and decided to choose the regression analysis models.

2.2 Population Regression Model

INFL=  1 + 2*CPI +  3*UNEMP +  4*WGGR + Ui

2.3 Explanation of variables

• Dependent variable INFL: Inflation rate (%)

Inflation happens when the purchasing power of a given currency over time decreases. The increase of an average price level of a basket of selected goods and services can reflect the decline in purchasing power.

8

The Inflation rate is the percentage increase or decrease in prices during a specified period, usually a month or a year. The percentage tells you how quickly prices rose during the period.

Inflation ratet = 100*(CPIt – CPIt-1)/ CPIt-1 Which: CPIt : Consumer Price Index this year CPIt-1: Consumer Price Index last year

• Independent variable CPI: Consumer Price Index (%)

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living. The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. The formula used to calculate the Consumer Price Index for a single item is as follows:

CPI =

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 𝑔𝑖𝑣𝑒𝑛 𝑦𝑒𝑎𝑟 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟

* 100

(In the report, the base year is 1983=100) • Independent variable UNEMP: Civilian Unemployment rate (%)

The unemployment rate is the percent of the labor force that is jobless. It is a lagging indicator, meaning that it generally rises or falls in the wake of changing economic conditions, rather than anticipating them. When the economy is in poor shape and jobs 9

are scarce, the unemployment rate can be expected to rise. When the economy is growing at a healthy rate and jobs are relatively plentiful, it can be expected to fall. The official unemployment rate is known as U-3. It defines unemployed people as those who are willing and available to work, and who have actively sought work within the past four weeks. Those with temporary, part-time, or full-time jobs are considered employed, as are those who perform at least 15 hours of unpaid family work. To calculate the unemployment rate, the number of unemployed people is divided by the number of people in the labor force, which consists of all employed and unemployed people. The ratio is expressed as a percentage.

UNEMP =

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝐿𝑎𝑏𝑜𝑟 𝐹𝑜𝑟𝑐𝑒

* 100

• Independent variable WGGR: Percent change in average weekly earnings, in current dollars (%) • The disturbance term of the model Ui represents other factors that affect INFL but not mentoned in the model.

2.4 Description of the data

2.4.1 Data sources This set of data was collected based on the data set 2-3 of Ramanthan form the source of Economic Report for President govinfo.gov, includes 47 observations of United States in 47 years from 1966 to 2012.

2.4.2 Statistical description of the variables To get the statistic indicators of the variables, in STATA, we use the command sum infl cpi unemp wggr 10

and receive the table below: Table 1. Summary Statistics, using the observations 1966 – 2012 Variable

Obs

Mean

Std.Dev

Min

Max

infl

47

4.353191

2.808748

-0.4

13.5

cpi

47

123.7377

62.32767

32.4

229.594

unemp

47

6.148936

1.669401

3.5

9.7

wggr

47

4.104255

1.852021

1.5

8.5

(Source: the team synthesized under the support of Stata software) According to the statistic table above, we can see that almost all the Standard Deviation (Std.Dev) is much smaller than the mean, the value of maximum and min...