Page 10 - AEI Insights 2020 - Vol. 6, Issue 1

AEI Insights, Vol 6, Issue 1, 2020

where π is inflation rate, k is constant, α is slope parameter and u is unemployment rate. This
fundamental relationship could be modified by incorporating expectation. The expectations-
augmented relationship could be expressed as (Ball and Mankiw, 2002):

∗
= − ( − ) (2)

e
where π is expected inflation rate and u* is natural rate of unemployment rate. Under the
assumption of adaptive expectations, the expected inflation rate is equal the inflation rate in
the past. The adaptive expectations-augmented relationship can be expressed as (Ball and
Mankiw, 2002):

∗
= −1 − ( − ) (3)

where is inflation rate at last period. This equation could be re-formulated to (Ball and
−1
Mankiw, 2002):

∗
− −1 = − (4)

For the purpose of econometric estimation, supply shock could be incorporated into this
equation (Ball and Mankiw, 2002):

= − + (5)
∗

where Δπ is change in the inflation rate and v is supply shock which is an error term in this
equation. In other words, natural rate of unemployment rate could be estimated by regressing
change in the unemployment rate (Δπ) on unemployment rate (u) and an intercept (αu*). The
absolute value of intercept divided by slope parameter is the natural rate of unemployment rate.

Table 3 reported the estimated natural rate of unemployment or equilibrium unemployment
rate in ASEAN countries. It should be noted that the natural rate of unemployment in five
countries in mainland Southeast Asia are less than two percent. It means that these countries
would enjoy lower unemployment rates in an equilibrium labour market where their labour
demand is equal to their supply. Other ASEAN countries, except Brunei and Indonesia, would
have moderate level of equilibrium unemployment rates which are less than 4 percent.

Countries Slope parameter Intercept Natural rate of
unemployment (u*)
(α) (αu*)
Brunei 0.03 -0.33 8.87

Indonesia -0.11 0.86 7.32

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