Inflation, Unemployment, and Growth: Testing the Trade-Offs in Emerging Economies

Abstract

This paper aims at reconsidering three classical macroeconomic relationships (the Phillips curve, Okun's law and the inflation–growth nexus) in a unique empirical setting of emerging economies. The study uses an unbalanced panel of 34 emerging market economies over the period 2000-2023 using the World Bank's World Development Indicators (WDI), and estimates each of the relationships separately and together, with the inclusion of gross capital formation, trade openness, government consumption and level of financial development. The use of panel fixed-effects and two-step system generalised method of moments (GMM) estimators is used to deal with unobserved heterogeneity and dynamic endogeneity issues. The Phillips curve trade-off is statistically significant; but it is relatively small in economic terms: a one-percentage-point increase in the unemployment rate reduces the inflation rate by about 0.28 percentage points. Okun's law is found to be a very strong relationship: a one-percentage-point increase in the unemployment rate is associated with a 0.41 percentage-point decline in real GDP growth. The relationship between inflation and growth is nonlinear and a threshold model identifies the turning point as around 9.4% annual inflation, beyond which increases in inflation have a much greater impact on growth. The results point to a cautious inflation targeting policy in the emerging markets: the estimated Phillips slope implies that disinflation carries real output costs, although the sacrifice ratio itself is not calculated here and no direct comparison of disinflation costs with the advanced economies is claimed.