Inflation, Unemployment and Uncertainty in the Frequency Domain

Miescu, Mirela Sorina and Fasani, Stefano (2024) Inflation, Unemployment and Uncertainty in the Frequency Domain. Working Paper. SSRN Working Paper.

Abstract

This paper employs the frequency domain to examine the relationship between inflation uncertainty and unemployment. Inflation uncertainty explains 27% and 19% of the forecast error variance of unemployment in the long run for the US and UK, respectively, while its effects on other variables are limited to the short run. The analytical solution of a New-Keynesian model with downward nominal wage rigidity (DNWR) shows that higher inflation uncertainty raises long-run unemployment. With higher nominal volatility, DNWR limits downward wage adjustments, raising expected unemployment and extending the inflation-unemployment relationship beyond the short-run Phillips Curve.