DP1483 | Short- and Long-run Phillips Trade-offs and the Cost of Disinflationary Policies

Publication Date

31/10/1996

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Abstract

This paper studies the joint behaviour of inflation and unemployment in Spain over the period 1964?95 in order to estimate dynamic Phillips trade-offs and sacrifice ratios in response to a demand shock. We organize our empirical approach as a structural (albeit eclectic) one. In so doing, we use a Structural VAR to identify demand shocks in a framework where the high persistence in both series allows us to differentiate between permanent and transitory components. Our eclecticism comes from using three alternative identifying schemes which fit the data equally well, but place different emphasis on the effects of demand shocks on the unemployment rate. Our estimates suggest, according to the reader?s prior belief (Keynesian or monetarist), that a one percentage point reduction in inflation following an aggregate demand contraction is associated with cumulated output losses of between 2.6% and 5% over five years.