An investigation of the relationship between inflation and unemployment in selected Eurozone countries

Abstract

Two main issues that are of priority to policymakers are those of inflation and unemployment, and economists have long carried out research as to whether a relationship exists between these two variables. A.W. Phillips discovered that the UK had a negative relationship between inflation and unemployment during the period 1861 to 1957, as an increase in the inflation rate led to a fall in unemployment. This dissertation investigates the relationship between inflation and unemployment for a sample of 6 countries - Cyprus, Latvia, Lithuania, Malta, Slovakia, and Slovenia. These countries all joined the European Union in 2004, and then over time also went on to adopt the Euro currency. Data for the period from 2004, which was the year each country joined the EU, until 2022 on a quarterly basis is used and analysed through OLS regression before and after Euro adoption. In addition, a multivariate regression is carried out for each country to investigate the effect of two other important economic markers, interest rates and unit labour costs, together with inflation, on unemployment. Finally, a Vector Autoregression was carried out in order to also consider the effect of previous values of the same variables. Results confirmed the anticipated negative relationship between inflation and unemployment in each of the selected countries. However, this relationship varies in magnitude depending on the country concerned. When looking at the multivariate regression, relationship signs with all variables are also as anticipated. This is evident in the OLS and multivariate regression models, in particular after Euro adoption, indicating that the economic policies required for Euro adoption have a similar effect in the different countries, albeit at different levels of strength and significance.