Working Papers in Economics,
University of Gothenburg, Department of Economics

Abstract: The object of the paper is to attempt to assess the two classical long-run neutrality; the Fisherian link between inflation rate and nominal interest rate, and the natural rate hypothesis proposed by Friedman(1968) and Phellps (1967, 1968). We use the quarterly data for Japan, Sweden and Italy. In order to investigate the classical long-run neutrality, we use the non-structural bivariate autoregressive methodology King and Watson (1997) developed to avoid the Lucas-Sargent critique. They showed that long-run neutrality can be tested with limited structural information when nominal variables are integrated.

We pay close attention to the unit root properties of the data, since it takes very crucial role in applying their methodology. Our test results show that all data of Japan, Sweden and Italy we use here do not have unit root and cointegration. The empirical evidences of the Fisherian link and the long-run Phillips curve in Japan, Sweden and Italy are consistent with those of United States by King and Watson (1997). The classical Fisherian link which means that permanent shift in inflation rate will have no effect on real interest rate would not be accepted. On the contrary, we could find little evidence against the vertical long-run Phillips curve. A long-run trade off between inflation and unemployment was rejected.

Keywords: long-run neutrality; unit root; cointegration

JEL-codes: E44; E52; E58

20 pages, First version: August 31, 2002. Revised: March 27, 2003.

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