Inflation and unemployment in South Africa: Is the Phillips curve still dead?

Abstract

It is regularly contended that the overly strict application of inflation targeting stifles employment growth in South Africa, with the contentious Phillips curve often used as seemingly authoritative reference. Proponents of this hypothesis argue that there is a trade-off between inflation and unemployment, which might be exploited to reduce the unemployment rate. Inflation-targeting central banks are consequently lambasted for their attempts to keep inflation low – attempts which could arguably contribute to higher unemployment. In response to conflicting results in the literature, a number of Phillips curve formulations are estimated to test this hypothesis in the modern South African economy. The article addresses a significant shortcoming in the existing South African literature by directly testing the relationship between inflation and the unemployment rate, instead of relying on traditional approximations of this relationship through variables such as the output gap or economic growth which might have contributed to the confusion in the first place. In the short run it finds no evidence of a trade-off between inflation and the unemployment rate, thus confirming the orthodox view, while there is conflicting evidence of a positive relationship between inflation and employment growth. The long-run estimation finds strong evidence of a negative relationship between inflation and employment, which leads to the conclusion that inflation harms employment creation.

Keywords: employment creation, error correction, inflation, Phillips curve, unemployment rate