Demand, unemployment and inflation

Our project consists of three sub-project. In sub-project 1, Aggregate demand and persistent unemployment, we will explore the reasons for persistent high unemployment in Europe. The dominating view is that this is caused solely by institutional factors, while an alternative view is that persistent fluctuations in aggregate demand have also been important. A key argument in favour of the institutional explanation is that if low aggregate demand were to push unemployment above its equilibrium level for lon ger periods, this would lead to consistent reductions in the rate of inflation, which we generally do not observe. We will investigate whether this argument is misleading, by exploring to what extent rigidities in wage setting prevent inflation from falli ng, even if unemployment is above its equilibrium value. We will also explore the relationship between persistent fluctuations in unemployment and fluctuations in aggregate demand by use of two panel data sets: one for the Nordic countries, and one for a larger number of OECD countries. In subproject 2, Wage-price dynamics, the NAIRU, and structural change, we will explore wage formation and the NAIRU in the Nordic countries. Much of the existing evidence on these issues stems from data that ends in the early or mid 1990s. Since then, deep structural changes have taken place, relating inter alia to wage bargaining systems and the pattern of international trade. Importantly, monetary policy is now directly focused on keeping inflation low. We will compar e the differences between two approaches to wage setting behaviour and equilibrium unemployment - the Phillips curve approach and a more general model of equilibrium unemployment. This distinction matters as some key policy implications differ between the approaches. In sub-project 3, Nordic macroeconomic database, we will update the data set used in our previous research (which ends in 1994). The updated data set will be used in subprojects 1 and 2.