AN ANALYSIS OF CAUSALITY BETWEEN INFLATION RATE AND UNEMPLOYMENT RATE IN EAST JAVA
NANANG BAGUS SETIAWAN 115020107121007
JOURNAL
Presented to University of Brawijaya in Partial Fulfillment of the Requirements for the Degree of Bachelor of Economics and Business
INTERNATIONAL PROGRAM IN ECONOMICS
FACULTY OF ECONOMICS AND BUSINESS UNIVERSITY OF BRAWIJAYA
MALANG 2015
AN ANALYSIS OF CAUSALITY BETWEEN INFLATION RATE AND UNEMPLOYMENT RATE IN EAST JAVA
Nanang Baagus Setiawan
Supervisor : Devanto Shasta Pratomo,SE., M.Si, Ph.D Economics Development Major Faculty of Economics and Business
University of Brawijaya Email: [email protected]
Abstract
Data is collected in the form of time series in the form of annual that is quantitative in the past years 1999-2014 .Data analysis technique used namely research namely adopting both granger causality cointegration test and test and correlation analysis.
The results of a test using granger causality cointegration test and test .Granger causality analysis test can be seen that the unemployment rate influences the level of inflation in East Java and inflation does not influences the level of unemployment in East Java. The analysis correlation it can be seen that there is the relationship between child inflation with the unemployment rate, this is shown obtained correlation value of 0,610 and a sig. = 0,012 .That means that there is a strong correlation between the level of inflation with the unemployment rate which has indicated by the correlation figure among 0,60-0,799 range .
Keywords: Inflation Rate and Unemployment Rate
A. INTRODUCTION
An ideal economy marked with high economy growth, a controllable inflation rate, a stable exchange rate and interest rate and also a low unemployment rate or even the achievement of full employment is an economy condition that is anticipated from a city’s development. In order to achieve the ideal economy mentioned above, the city’s government should continually operate the various programs and policies, in both the fiscal and monetary sector.
There are several efforts done by the government to achieve the ideal economy, such as through the policies in the fiscal sector which is the government budget policy from both revenues and expenditures. One of the fiscal policy instruments is tax. Meanwhile, the monetary sector policy is an effort to control the number of money supply in society. This policy can be done through a strict money policy (to reduce the circulating money)is called as a contractive monetary policy and an expansive monetary policy to increase the amount of circulating money (Rahardja and Manurung, 2004).
Inflation is an economic phenomenon that is feared by every nation in the world, including Indonesia. If the inflation is suppressed, it can result in the
increase of unemployment rate, whereas unemployment is one of the symbols from the low national production that can affect the economy growth (Maknun, 1995).
Inflation in short can be defined as the price increase of goods. With the increase of the price, the economy will suffer instability and will affect the behavior in both society and government. In line with that, the society’s interest to save money decreases. Then, to withdraw the circulating money, the government increases the interest rate that results in the decrease of interest to invest, which means there is the accumulation of capital to decrease the tendency causing interference to economic development and stability.
Other than that, inflation can also affect the instability of the real sector productivity, the declining of the competitiveness of export commodity in the international market, the instability of the society distribution income, and many more economic variables that is affected by inflation. Thus, through UU No. 23 Tahun 1999, which was then revised with UU No. 3 Tahun 2004, the government together with the Indonesian Bank will try to control and achieve the inflation target that has already been set so the economic stability and growth can be achieved and sustainable (Setyawan, 2005).
Other than inflation, another aspect that contributes to the economic development and growth is the unemployment rate. Unemployment is one of the short term main issues that is always faced by every city. As of that, every economy in a city faces the unemployment issue which is the natural rate of unemployment. Speaking about unemployment, social and economic issue cannot be avoided because unemployment other than it causes a social issue it also affects the economic growth of a city.
B. LITERATURE REVIEW
In this chapter, the discussion about the definition of some topics in research will be explained.
Definition of Inflation
Inflation is the goods price rise phenomenon that is general and persistent (J.M Keyness,1946). From this definition, there are three components that have to be fulfilled to illustrate the happening of inflation, namely:
1. Price increase 2. General
3. Happens continuously
The price of a commodity is said to rise if be higher than the price the previous period .For example , gasoline prices a liter on 1 march 2005 ago was IDR .2.400,00 .And on 24 may 2008 to IDR .6.000,00 .Means gasoline prices per liter day IDR .3.600,00 much more than in 2005 ago .It can be said there has been the increase in gasoline prices .The comparative degree price is also could be done by the space of which is longer; a week, a month, quarter, or one year (PERMEN ESDM, 2008).
Inflation Indicator
There are some economic macro indicators that is used to calculate the inflation rate during a one year period, those are:
1. Gross Domestic Product (GDP) Deflator
GDP deflator is an economic metric of the dividing between nominal GDP and real GDP that can measure the level of price in influence be inflation. It also can convert output measure at current prices into constant-rupiah GDP. The GDP deflator show how much a change in the base year’s GDP relies upon changes in the price level.
2. Consumer Price Index
Consumer Price Index (CPI) is an index number that shows the goods and service price rates that has to be bought by the consumer in a certain year period. The CPI is obtained by calculating the main goods and services price that are consumed by society in a certain year period. Each goods and services price is weighted based on the degree of significance.
The goods and services that are considered the most important are weighted the most (www.bls.gov, 2015).
The inflation rate based on CPI is obtained by using an equation as follows:
Inflation year t = CPI (year t ) – CPI (year t-1) X 100%
Examined from the calculated commodity scope, CPI roughly reflects the actual inflation rate. However, CPI is very useful because it illustrates the living cost increase magnitude for consumers because CPI inserts relevant commodities that are usually consumed by society.
Inflation Theories
There are some theories in economy that explains about inflation (Boediono, 2001):
Quantity Theory of Money
Based on Irving Fischer (transaction equation) is:
P.T = M.V Description:
P = Price Rate
M = Number of Circulating Money (Money Supply) V = the Velocity of Money Circulation
T = Transaction Volume
In this equation, it suggests that all transaction sales is equal to whole purchase value. The transaction value is multiplied with the price, while the transaction purchase value is equal to the number of money supply multiplied with the average velocity of money circulation.
CPI year t-1
From the formula above, it can be concluded that the inflation process is caused by:
a. The Volume of Money Supply
Inflation can only happen if there is an additional volume of money supply in the society (currency money and demand deposits money).The addition of this money supply is the main source of inflation because the money supply volume is bigger than the output ability absorbed (a great volume from the national income).
If the amount of money supply is not added, inflation will increase automatically.
b. The Society’s Expectation About Price Increase
It is predicted that there will be a price change in society even though there is addition that does not result in inflation because the price change is still little. If there is a significant price change and the addition of money supply is not added, inflation will automatically stop whatever the cause of the price increase in the economy.
The Definition of Unemployment
In the economic definition, unemployment is not identical with not wanting to work. One is said to be unemployed if that person wants to work and have tried to find work but has not acquired it (Sukirno, 2004).
In the science of demography, a person who seeks work is categorized into the population group that is called the labor force. Based on the age, the age of the labor force is 15-64. However not all people aged 15-64 is counted as the labor force. The residents that are counted as the labor force are residents aged 15-64 and is seeking work, while those who do not seek work whether they are taking care of their family or school are not included in the labor force. The unemployment rate is a labor force percentage that is not/yet been able to get work. The following diagram will give further explanation (Sukirno, 2004).
The types of unemployment mentioned above, the types of unemployment in developing countries can also be divided into several types as follows:
a. Covert Unemployment
If in an economic activity, the number of labor force is over abundance there will be converted unemployment or distinguished unemployment.
b. Open Unemployment
Open unemployment are those who are not working both voluntarily and forced.
c. Underemployment
Half unemployment are workers who have less working time than their desire. It can also be defined as people who want to work but have not been utilized fully. It means that their working time in a week is less than 35 hours. They who seem to work but actually are not that productive, those who are categorized into open or converted unemployment but working under the standard of optimal productivity.
They who cannot work fully, for example the disabled who have the desire to work but their physical condition do not support them, making it impossible.
They who are not productive, those who actually have the ability to do productive
jobs but they do not have adequate complement resources to produce output; what they only have is power thus even though they have already worked hard, the result is still not adequate.
C. RESEARCH METHOD
This research focuses on analyzing the relationship between the inflation rate variable and the unemployment rate in East Java. The unemployment rate used in this research is open unemployment rate.
The data that are collected, used, and also processed in this research are secondary data. Those data are the results obtained from the official authorities or agencies that are related to this research. The data are obtained in form of yearly Time Series in the year period of 1999-2014 in which they are quantitative.
The data sources are from the Central Statistics Agency (CSA). Other than that, other data that support this research are obtained from literary source such as journals, articles, and other literature that are related to this study. To process the data in this research, the writer uses the program Stata 12 and SPSS released 21.
Operation Variables
Variables Definition Scale
Unemployment rate (Y) An open unemployment rate which is the number of residents that is categorized into the labor force but do not have jobs in East Java.
In percentage
Inflation rate (X) A general and
continuously increase of price rate that is measured by using the Gross Domestic Product during the 1999-2014 period in East Java
In percentage
D. ANALYSIS RESULT
The analysis on the relationship between the level of inflation with the level of unemployment in complete can be presented in table.
Analysis of the Correlation between Inflation Rate and Unemployment Rate in East Java
Correlations
Inflation Unemployme nt
Inflation
Pearson Correlation 1 ,701**
Sig. (2-tailed) ,002
Sum of Squares and Cross-products
102,815 27,055
Covariance 6,854 1,804
N 16 16
Unemployme nt
Pearson Correlation ,701** 1
Sig. (2-tailed) ,002
Sum of Squares and Cross-products
27,055 14,493
Covariance 1,804 ,966
N 16 16
Sources: data was processed by author (2015)
Based on table 4.6 can be known to the relationship between the inflation rate to the level of unemployment that occurs in East Java province, and retrieved the value of the correlation of 0,701 and sig. = 0.002. This condition indicates that there is a significant relationship between the inflation rate to the level of unemployment. This means that the higher inflation rate the higher rate of unemployment. But instead the lower inflation rate then the lower unemployment rate anyway. According to Sugiyono (2007) provide guidelines for the interpretation of the correlation coefficient is as follows:
0,00-0,199 = Very low 0,20-0,399 = Low 0,40-0,599 = Middle 0,60-0,799 = Strong 0,80-1,00 = Very strong
Based on the results of the analysis of the correlation test then it can be noted that the results of the analysis of obtained correlation of 0.60-0,799 figures that fall into the category of strong.
A theoretical basis used in behavior test data the level of inflation and interest rates is the root of a unit of test developed by dickey fuller (1979- 1981).This test done to see the validity of a data .This testing is treated to avoid a model of direct or bias ( inefficient ) .Test root - the root of the unit and the degree of integration is using the ADF ( augmented dickey fuller ) statistics to the 1999 period of time until 2014 .The following is test root- the root of the unit to see whether the data obtained stationary and look at the degree or order difference to how the data will be stationary observed using test integration degrees.
The Results of The Estimation of The ADF and The Degree of Integration of The Unit Root Test
Variable Level AIC SC First Second
0 4.67746 4.72092
Unemployment 1 4,41393* 4,50085* -.3259699 .574843
Inflation 2 4,49965 4,63002 -1.216876 1.298119
(* = Is considered as the smallest of level) Source: data was processed by author (2015)
Then to find hose optimal sought by using many criteria information available and in writing these criteria used AIC ( Akaike Information Criterion ) and SC ( Schwarz Information Criterion ) and the result of AIC and SC stated in output to be taken the smallest interpret that the was a optimum lag. Intermediate results lag 1 to 2 show lag value AIC and SC the smallest is at lag amounting to 1 4,41393* and 4,50085* Which means hose optimal is at hose 1. In table visible value AIC lag 2 on larger than lag 1 at the AIC amounting to as much as 4,49965 and SC as much as 4,63002 But in the determination of the optimum used hose value AIC and SC which is equally smallest so it is not only based on one criteria information. But based on two criteria in together (Lestari, 2009).
Granger causality Test
Test causality granger essentially aimed to determine whether there was an association between variables is statistically inflation and unemployment in East Java.
a. Through this test can be seen whether the second variables having , namely: relations two directions ( affect each other)
b. Relations one direction
c. There is no relationship (not affecting)
The Result of Granger Causality Test
Hypothesis Observation F-Statistic Probability
Ha : Unemployment
influences the inflation
16 6,1006 0,047
Ho: Inflation influences the unemployment
16 1.8292 0,401
Sources: Data is processed by the author (2015)
This will be an analysis of estimating results test causality granger to variable rate of inflation and unemployment in East Java for the period from 1999 until 2014.
Based on the results of a test of granger causality above shows that between the levels of inflation with the level of unemployment in East Java relations causality there is one direction, where the rate of unemployment affect the level of inflation.
This can be seen the value F- statistic, where F calculate > F table (6,1006>3,682) significant at the 1 percent level of confidence. These results indicate that the existence of a relationship that effects of unemployment rate to the inflation rate in East Java.
Cointegration Test
Granger test aims to find out the hyphen an balance in the long term between the inflation rate with the unemployment rate in East Java. This test can be done with a test of Engle-Granger or test Augmented Engle-Granger (AEG).
This test is performed by utilizing Test DF-ADF.
The steps obtained to do testing AEG are:
1. Do estimation model 2. Get residual of the model
3. Is it already testing stationary, if residual has been stationary, means that there are cointegration.
Cointegrating Equations
ADF Critical Value Stationary
36.7700 15.41 I(0)
Source: data was processed by author (2015)
The following are testing shows cointegration by test augmented Engle- Granger between the level of inflation with the level of unemployment in East Java in the last years 1999-2014.Based on the ADF statistics obtained for residual 36.7700 is as much as , while the value of critical to the level of significance 5 percent 15.41. This result reflects the ADF greater than the value of critical .Thus can be concluded that the value of residual has been stationary , in other words that there are cointegration between the level of inflation with the level of unemployment in East Java in the past year 1999-2014 .The results of this in accordance with the hypothesis put forward , namely that between the level of inflation with the level of unemployment in East Java have cointegration, that means that between the level of inflation with the level of unemployment in East Java have balance in the long term.
E. CONCLUSION AND RECOMMENDATION
The conclusion and recommendation will explain the result of the research in a brief summary.
CONCLUSION
From the results of research and discussion with using analysis granger causality test and test cointegration and correlations that has been done then conclusions may be drawn as follows:
1. Test results using Granger Causality Tests and Cointegration Analysis of Granger Causality tests. tests can noted that Unemployment rates affect the inflation rate in East Java, while the Inflation rate does not affect unemployment rates in East Java.
2. The analysis correlation can be seen that there is the relationship between the level of inflation with the level of unemployment, this is shown obtained correlation value and worth 0,701 sig. = 0,002. It means that
there is a strong correlation between the level of inflation with the level of unemployment shown with a correlation of between span 0,60-0,799 RECOMMENDATION
After studying, analyzes and conclude from the research has been done, which includes some suggestions and proposed:
1. In an effort to reduce the impact of inflation in East Java condition hence strengthen basic sector of the economy that was found in East Java. Efforts to strengthen the position of this economy provides support in efforts to accelerate economic growth and provide support in efforts to open work opportunities so can reduce the level of unemployment that occurs.
2. Efforts to strengthen the position of macro and micro economy will support the process of economic control performed. This effort was done to give assurance to suppress the impact of the occurrence of inflation.
3. Researchers expected for next to use of other variables that related to the level of unemployment and is expected to add a period of time so that the results of (the period) subsequent research can be more developed.
Appendix 7.1: Inflation in East Java 1999-2014 Years Inflation
(%)
Unemployment (%)
1999 5.6 4,11 2000 1.6 4,52 2001 9.9 4,35 2002 1.4 4,90 2003 4.9 4,81 2004 2.14 5,72 2005 4.3 5,82 2006 8.0 5,38 2007 7.1 7,45 2008 9,6 6,24 2009 6.2 5,87 2010 5.2 4,91 2011 4.9 4,18 2012 7.7 4,14 2013 3.6 4,00 2014 6.7 4,02 Source: Central Bureau Statistic (2015, January) Appendix 7.2: Auto regression
Equation Parms RMSE R-sq chi2 P>chi2 --- dx 5 12.8614 0.4298 9.799446 0.0439 dy 5 .793854 0.4202 9.422713 0.0514 ---
--- | Coef. Std. Err. z P>|z| [95% Conf. Interval]
---+--- dx |
dx |
L1. | -.6013237 .2549616 -2.36 0.018 -1.101039 -.101608 L2. | -.4909102 .3083832 -1.59 0.111 -1.09533 .1135099 |
dy |
L1. | -5.204701 4.632032 -1.12 0.261 -14.28332 3.873916
L2. | -1.718396 4.017557 -0.43 0.669 -9.592663 6.155872 |
_cons | -1.131698 2.824877 -0.40 0.689 -6.668356 4.40496 ---+--- dy |
dx |
L1. | -.0429807 .0157372 -2.73 0.006 -.073825 -.0121364 L2. | -.0152713 .0190345 -0.80 0.422 -.0525783 .0220357 |
dy |
L1. | .0038461 .2859058 0.01 0.989 -.556519 .5642112 L2. | .1237477 .2479782 0.50 0.618 -.3622806 .609776 |
_cons | -.0724157 .1743617 -0.42 0.678 -.4141582 .2693269 ---
Appendix 7.3: Cointegration Equation
Equation Parms chi2 P>chi2 --- _ce1 1 16.25845 0.0001 --- Identification: beta is exactly identified
Johansen normalization restriction imposed
--- beta | Coef. Std. Err. z P>|z| [95% Conf. Interval]
---+--- _ce1 |
dy | 1 . . . . . dx | .2003597 .0496902 4.03 0.000 .1029687 .2977507 _cons | .1121791 . . . . .
Appendix 7.4: The Result of Granger Causality Test
Hypothesis Observation F-Statistic Probability Unemployment influences the
inflation
16 7.5723 0,023
Inflation influences the unemployment
16 1.6256 0,444
Appendix 7.5: Correlations
Analysis of the Correlation between Inflation Rate and Unemployment Rate in East Java
Variables Description Inflation Unemployment
Inflation Pearson Correlation Sig. (2-tailed) Sum of Squares and Cross-products Covariance N
1 2146,683
143,112 16
0,610 0,012 107,638
7,176 16 Unemploy
ment
Pearson Correlation Sig. (2-tailed) Sum of Squares and Cross-products Covariance
0,610 0,012 107,638
7,176 16
1
14,493 0,966
16
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