The Possible Unemployment Cost of Average Inflation below a
Lars E.O. Svensson
Department of Economics, Stockholm School of Economics;
Stockholm University; CEPR; and NBER
First version: April 2012
This revision: December 2013
American Economic Journal: Macroeconomics 7(1) (2015) 258-296.
The Riksbank in 1993 announced an official target for annual CPI inflation of 2 percent to apply from 1995. Over the 15 years since then, 1997-2011, average CPI inflation has equaled 1.4 percent and has thus fallen short of the target by 0.6 percentage points. In contrast, in Australia, Canada, and the U.K., which have had a fixed inflation target for as long as Sweden, average inflation has been on or very close to the target. Has this undershooting of the inflation target in Sweden had any costs in terms of higher average unemployment? This depends on whether the long-run Phillips curve in Sweden is vertical or not. During 1997-2011, average inflation expectations have been close to the target. The inflation target has thus been credible. If inflation expectations are anchored to the target also when average inflation deviates from the target, the long-run Phillips curve is no longer vertical but downward-sloping. Then average inflation below the credible target means that average unemployment is higher than it would have been if average inflation had been on target. The estimates reported suggest that the average unemployment rate has been about 0.8 percentage points higher. This is a large unemployment cost of undershooting the inflation target. Some simple robustness tests indicate that the estimate of the unemployment cost is rather robust.
JEL Classification: D84, E24, E31, E52, E58
Keywords: Non-vertical long run Phillips curve, inflation targeting, policy evaluation