Unemployment and inflation in Western Europe: solution by the boundary element method

TL;DR

This paper models unemployment and inflation in Western Europe and the US using a boundary element method analog, achieving high explanatory power without relying on stochastic processes.

Contribution

It extends a deterministic boundary element model of unemployment-inflation dynamics to Western Europe and the US, with successful long-term predictions.

Findings

Model explains 65-95% of variability in unemployment and inflation.

Accurate nine-year unemployment forecast for Italy with 0.55% RMS error.

Predicted unemployment growth in Italy reaching 11.4% by 2012.

Abstract

Using an analog of the boundary element method in engineering and science, we analyze and model unemployment rate in Austria, Italy, the Netherlands, Sweden, Switzerland, and the United States as a function of inflation and the change in labor force. Originally, the model linking unemployment to inflation and labor force was developed and successfully tested for Austria, Canada, France, Germany, Japan, and the United States. Autoregressive properties of neither of these variables are used to predict their evolution. In this sense, the model is a self-consistent and completely deterministic one without any stochastic component (external shocks) except that associated with measurement errors and changes in measurement units. Nevertheless, the model explains between 65% and 95% of the variability in unemployment and inflation. For Italy, the rate of unemployment is predicted at a time horizon of nine years with pseudo out-of-sample root-mean-square forecasting error of 0.55% for the period between 1973 and 2006. One can expect that the u nemployment will be growing since 2008 and will reach 11.4% near 2012. After 2012, unemployment in Italy will start to descend.