Some International Evidence on Output-Inflation Tradeoffs.

TLDR: In this paper, the results of an empirical study of real output-inflation tradeoffs, based on annual time-series from eighteen countries over the years 1951-67, were examined from the point of view of the hypothesis that average real output levels are invariant under changes in the time pattern of the rate of inflation.

Abstract: This paper reports the results of an empirical study of real output-inflation tradeoffs, based on annual time-series from eighteen countries over the years 1951-67. These data are examined from the point of view of the hypothesis that average real output levels are invariant under changes in the time pattern of the rate of inflation, or that there exists a "natural rate" of real output. That is, we are concerned with the questions (i) does the natural rate theory lead to expressions of the output-inflation relationship which perform satisfactorily in an econometric sense for all, or most, of the countries in the sample, (ii) what testable restrictions does the theory impose on this relationship, and (iii) are these restrictions consistent with recent experience? Since the term "'natural rate theory" refers to varied aggregation of models and verbal developments,' it may be helpful to sketch the key elements of the particular version used in this paper. The first essential presumption is that nominal output is determined on the aggregate demand side of the economy, with the division into real output and the price level largely dependent on the behavior of suppliers of labor and goods. The second is that the partial "rigidities" which dominate shortrun supply behavior result from suppliers' lack of information on some of the prices relevant to their decisions. The third presumption is that inferences on these relevant, unobserved prices are made optimally (or "rationally") in light of the stochastic character of the economy. As I have argued elsewhere (1972), theories developed along these lines will not place testable restrictions on the coefficients of estimated Phillips curves or other single equation expressions of the tradeoff. They will not, for example, imply that money wage changes are linked to price level changes with a unit coefficient, or that {"long-run"' (in the usual distributed lag sense) Phillips curves must be vertical. They will (as we shall see below) link supply parameters to parameters governing the stochastic nature of demand shifts. The fact that the implications of the natural rate theory come in this form suggests an attempt to test it using a sample, such as the one employed in this study, in which a wide variety of aggregate demand behavior is exhibited. In the following section, a simple aggregative model will be constructed using the elements sketched above. Results based on this model are reported in Section II, followed by a discussion and conclusions.