Investigating The Relationship Between The Bank Rate, Unemployment And Inflation: The Phillips Curve In Namibia

ABSTRACT

This study investigates the relationship between the bank rate, unemployment and inflation rates in Namibia, and it also interrogates the policy implications of using the bank rate as a policy instrument not only to maintain price stability, but also to influence the unemployment rate in Namibia. In the same vein, the study aims to find out whether the Phillips curve is applicable to the Namibian economy, by using times series data of inflation, unemployment and bank rate from 1961 to 2012 and employing the Vector Auto Regression (VAR) model to estimate the data. The ADF and PP unit root tests are used to test for stationarity in the data and both these tests find all variables to be stationary at first difference. To test whether a long-run relationship exists between the variables, the Johannsen cointegration test is used which rejects the null hypothesis of no cointegration at 5 percent level of significance. This implies that the variables are associated and move together in the long-run. As a result of the cointegration which is detected among the series, the vector error correction (VEC) model is then employed to investigate for short-run properties between the variables. Through the VEC model, the Granger causality test, impulse response functions as well as the variance decomposition test are estimated. The Granger causality test identifies a single unidirectional causality in the series in the case whereby bank rate Granger causes inflation, and this implies that monetary authorities in Namibia do not make decisions about inflation in isolation from the bank rate. The main results reveal that the rates of inflation and unemployment in Namibia are significantly explained by the changes in the bank rate. This means that the bank rate can be used as a suitable policy instrument to address the two evils of inflation and unemployment in the country. The results also indicate that the inflation and unemployment rates are inversely related, which confirms the existence of the Phillips curve in Namibia.