Modeling Inflation Rate and Unemployment Rate in Sri Lanka: Validation of Lucas Critique

EasyChair Preprint no. 6961

Abstract

The Phillip curve has been used by many macro economics policy makers in different countries on decision making process and policy making process on the inflation rate and the unemployment rate related issues in the country. However, economists argue that Phillips curve theorem fails and it misinform policy makers.  Although many studies have been conducted for and against the Phillips Curve theorem, less studies has been conducted on application of Phillips Curve in Sri Lankan economy and also there is paucity of literature on validating Lucas Critique in different economies. The analysis of annual inflation rate and unemployment rate in Sri Lanka from 1991 to 2020 is conducted using Vector Autoregressive Model. Johansen Co-integration Test shows that here is no co-integration presence between the relationship of the unemployment rate and inflation rate during the given period. Furthermore, it was found that one lagged unemployment rate and inflation rate shows a positive impact on the time series variables. Thus the study rejects the Phillips Curve relationship in Sri Lankan economy but supports Lucas Critique.

Keyphrases: Inflation, Lucas critique, Phillips Curve, Unemployment

@Booklet{EasyChair:6961,
  author = {I M G A S Illukkumbura and T S G Peiris},
  title = {Modeling Inflation Rate and Unemployment Rate in Sri Lanka:  Validation of Lucas Critique},
  howpublished = {EasyChair Preprint no. 6961},

  year = {EasyChair, 2021}}