Kazakhstan Institute of Management, Economics and Strategic Research Department of Economics
Economy of Kazakhstan
UNEMPLOYMENT & INFLATION
Student Seilkhanov Gaziz Instructor Alma Kudebayeva
TABLE OF CONTENTS I. Introduction A. Reasons for undertaking research B. Research methods C. Research structure Literature Review A. What determines unemployment? B. Concerns about inflation and price level C. Government policies regarding unemployment and inflation Political Directions and Economic Situation in Kazakhstan A. Fiscal policy in detail B. National Bank of Kazakhstan and the Monetary Policy Econometric Regression & Phillips Curve Unemployment & Inflation: Correlation Analysis Forecasting the Future General Interpretation of Results Conclusions References 3 3 4 5 5 5 7 8 10 10 13 14 18 19 24 25 26
IV. V. VI. VII. VIII. IX.
Reasons for undertaking research Over 18 years passed since the Republic of Kazakhstan obtained its independence.
During this period of time a good deal of history was written according to the way of development of CIS countries in general and Kazakhstan in particular. Even now, there keep appearing papers and books on the topic of comparisons in the establishment and economic growth between countries of post-Soviet expanse. Kazakhstan is the special case. It is undisputable that this country faced a bit different conditions than other CIS countries. Even though it was alike the Kyrgyz Republic in the reform velocity, still it differs from Kyrgyzstan in territories and resources it has. Kazakhstan runs a different policy, and the vision it has, does not coincide with the visions of countries, like Turkmenistan, where the president conducts his own ideas that lead to the presence of presidential cult. But that is not the point. The main reason, why this topic was chosen, is that the process of economic development strongly depends on two factors: unemployment and inflation. Further in this paper, the negative relationship between these indices will be discussed. Both unemployment and inflation show the level of growth through the variations in GDP (i.e. total production of goods and services during a period of time, difference between nominal and real GDP, total income received from the production of goods and services, etc.). As it is known, true and foreseeing actions can avoid the rise of cyclical unemployment, significant increase in the inflation level that can be transferred to hyperinflation. It is clear that the Republic of Kazakhstan crowned with laurels of the Soviet Union. It inherited the goal of stability and equality as well as fear of change, and
rule of economy. Now, the government that established a stability as a goal in its election campaign, tries its best in recovering from the global financial crisis through the nationalization of big enterprises, thereby „solving‟ the problems of crisis. The main goal of this paper is to show, how both unemployment and inflation affect the economy, and what are the policies to enhance a reasonable recovery from each kind of fluctuations.
Research Methods As this paper considers a more global approach, first of all, the issue will be faced
through the theory. Various thoughts and models will be discussed, main of them are Classical Model and Keynesian views on the economics. However, theory does not always appear as it is in reality, so the examples of real-world events and consequences will be given. Here some comparisons and analysis are about to be shown in order to provide some clearance in the relationship between theory and practice. Finally, to support the idea, somehow to prove the theory, and to forecast some future directions, the mathematical approach will be conducted. Well known Regression Analysis, Correlation Analysis and Trend Analysis will be used in determining the factors that influence the fluctuations, the factors that show the relationship of indices, and future conditions and possible solutions.
Research Structure The structure of this paper is pretty clear. It is organized in a manner that
everything is logical and sequential. Firstly, the review of literature will be of concern. Theories, thoughts, ideas and proposals of different authors will be mentioned. It is important to keep them in mind in order to make up a general view on the topic and construct a new, clear way of understanding and comprehending the case. After that, according to the recalled information from the sources, a complete economic situation in Kazakhstan will be described. It is needed to do so in order to construct a picture of economic development. Then, the mathematical analysis is in turn. Econometric Regression model is used here to clarify what concrete factors mostly foster the GDP to change. Correlation Analysis helps to identify how unemployment and inflation move towards each other. Use of Descriptive Statistics can help to find necessary variables for analyzing the trend that can give us information about possible future fluctuations. Help of Moving Averages and Exponential Smoothing is obvious. Last, the interpretation of obtained data and conclusions can all in all sum up the research done and make some suggestions.
II. LITERATURE REVIEW
In the ideal economy, real GDP would rise in the quick and stable manner. Moreover, the price level that can be measured both by GDP deflator and by Consumer Price Index, would stay unchanging, at least would grow with a very slow speed. As a result, unemployment and inflation would not be of a big deal. But in practice, experience
shows quiet clear that full employment and stable price level cannot be achieved automatically. Therefore, both these issues are about to be investigated in the nearest chapters (McConnell C., Brew S., Economics, 11th Ed.). A. What determines unemployment? Harvard University professor, N.G.Mankiw in his works describes labor force as the chief resource in the economy, and he claims that keeping workers employed is a paramount concern of economic policymakers (Mankiw, Macroeconomics, 5 ed.). In fact, he is right. Labor force plays a significant role in any economy. Still there is an opinion, which states that the more developed a country is, the more capital-oriented is it. Actually, in the course of time, labor force gradually had been losing its importance in the economy. As the production function primarily consists of capital, labor and technological advance, the last is taking more and more high speed of change that leads to decrease in the number of labor and in some cases the number of capital. As it is known, people are afraid of noises (Fischer Black, “Noise”). Any kind of new information hurt people, pushing them into some movements that they are not willing to do. It is observed that the majority of people (in some cases even all of them) are conservatives. With the beginning of industrial era, a so-called group of „luddites‟ appeared, the aim of whom was to defend the rights of labor; and therefore the area of their activities covered the mass destruction of capital equipment. According to the consumer theory that is provided by Campbell McConnell and Stanley Brew, people prefer doing less in order to receive the same output. Here this theory can be supported by the fact that it takes time, energy and resources to make a research and achieve a technological advance.
To clarify the term “unemployment”, it is suggested to define the opposite side, the full employment. According to McConnell and Brew, full employment consists of frictional and structural unemployment that are unavoidable. And that is absolutely right, because any time there is a certain number of unemployed labor force or other resources. For instance, every day there are exactly some people who are being sacked from their jobs or who graduate from colleges, and at the moment looking for a new job. In addition, technological advance enforces the production manner to change. Demand for certain kind of occupations decrease or even disappear (e.g. demand for post-officers with the development of Internet), at the same time creating new types of professions that are required. When the level of full employment decreases or even drops – the result is the sharp increase of unemployment rate. B. Concerns about inflation and price level What does inflation mean? Actually, inflation is the overall increase in the price level. However, in reality, not all price increase evenly. Some prices of goods and services can increase dramatically, some gradually and some even decrease in special cases. Economists believe that inflation is caused by two factors, first of which is the inflation of demand. Traditionally, the price level fluctuations are explained by the excess demand. In some cases, the economy can buy more stuff than it is able to produce (i.e. aspiring to a particular point that is not on the production possibilities frontier). The production sector is not able to overcome the higher demands by the increase of real production capacity. Consequently, this overvalued demand causes the increase in prices for temporarily fixed goods and services, thereby causing demand inflation.
Second factor is the inflation caused by the increase in the costs of production and the decrease in the supply. When there a rise in the price of production factors is observed, it becomes more expensive to purchase required resources for the same production. At the same time, if there is insufficient supply of goods and services, then of course prices of the last become to increase, thus provoking an inflation. Here it is clear that inflation and price level are closely interrelated amongst each other. C. Government policies regarding unemployment and inflation (Abel &
Bernanke) There exist two main policies that are devoted to stabilize the deviations caused by numerous life factors. They are: fiscal and monetary policy. Fiscal policy makes provision for the control of government budget. To be more specific, government of a country is privileged to maintain reasonable tax and government spending policies. The exceed of tax collections compared to government purchases leads to budget surplus. That is, state has excess money in its treasury to spend somewhere like on public goods (roads, military services, etc.) or lending (abroad as well as within its boundaries). On the contrary, if a government conducts an expansionary policy, it reduces taxes and widens government expenditures, thereby creating budget deficit. It is clear that an increase in government expenditures leads to an increase in output, which in other words is called as a total income or a total expenditure in the economy (i.e. GDP). So, if output increases, it undoubtedly leads to an increase in purchasing power parity. Classical economists claim that in long-run perspective, increase in income leads to an increase in both consumption and savings. Then, if
consumption increases, it leads to an increase in the demand for goods and services, and, as it is discussed above, the situation turns to a demand inflation. BUT, looking at the other side, savings also increase, indicating that the supply of labor will probably not increase, even decrease a bit, because it is possible that retirement ages can be lowered. Still this is theory, but it needs a bit deeper investigation. If the Ricardian equivalence is taken into account, then in the short-run period of time, any change in taxes cannot affect the consumption and savings because if there is a budget deficit, government immediately undertakes actions like issuing bonds. These bonds are all about to be paid back within the next, say, 20 years, that again lead to a budget deficit. Population‟s expectation is normal, because then the same government can easily launch a contractionary fiscal policy. So, in the short-run no inflation can be expected (at least rise in significance). What about unemployment and policies about it, here the picture is the same. We are talking about several markets in one turn. Money market is the market, where mostly monetary policy is taking part. Goods market deals with the fiscal policy. In the very short run, according to Keynes theory, each of the policies affect the labor market. More deeply, we are going to talk about it in the next section.
III. POLITICAL DIRECTIONS AND ECONOMIC SITUATION IN KAZAKHSTAN
A. Fiscal Policy in Detail Fiscal policy is described by economists as the change in taxes and government purchases. Usually there are two time periods, long-run and short-run perspectives. Classical economists believe that market is self-rehabilitating, and therefore there is no need in intervention of the government. Actually, market is not self-regulating so far, at least it needs a really long time. But here the sense is being lost. Everyone wants to maximize their profits in order to buy more goods and services. Nobody is going to wait, because life is short. So, the theory provided by Keynes looks pretty attractive. In the short-run he believes that fiscal policy is really time-lack. He says that fiscal policy is very political; so, in order to change the taxation and government expenditures, state should thoroughly analyze the benefits and costs, because every increase in spending leads to a decrease in real wages of workers, so effective labor force becomes worse-off. First of all, Keynes suggests that real wages a rigid. In other words, more often government establishes minimum wages, or there are labor unions that foster the employers to set minimum wages. In addition, employers always try to reduce turnover costs, that is they always minimize costs of hiring and training their employees. So, real wages are quiet rigid, and the overall price level is sticky. Then, there always exists some sort of unemployment. Not always the wages are paid as the employee works. A clear example is here in Kazakhstan. Most employees in Almaty receive a significantly higher salary than they really work for. So, this results in an appearance of efficiency wages, when the real wage is higher than the equilibrium
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wages. It undoubtedly creates an unemployment, because at higher wages there is an excess supply of labor due to a normal demand for the same labor. Figure 1 illustrates this model. W/P
W/P* - equilibrium real wage W/P – actual real wage LFE – equilibrium quantity of labor L1 – quantity of labor demanded L2 – quantity of labor supplied L2 > L1, so there is an unemployment
Dlabor L1 Figure 1. LFE* L2 L
Probably, the most popular model in estimating the consequences of these factors is the IS-LM model, that helps to define the effects on investments and savings, and liquidity of money respectively. So, if we suppose that government spending (further as „G‟) increase or tax rates (further as „T‟) decrease (i.e. expansionary fiscal policy), then this change immediately affects IS-curve, because with the increase in G, national savings (further as „S‟) decrease (i.e. S = Y – C – G , where Y – income, C - consumption). At the goods market, decrease in national savings immediately leads to an increase in real interest rate. This rise in real interest rate brings to the shift of IS-curve, that leads to an increase in output at full employment, by the result of which the inflationary gap is occurred.
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Obtained inflationary gap influences the aggregate demand (further as „AD‟), increasing it. Increase in AD is caused by the fact that the increase in production (output is increased) means that firms want to produce more by hiring more labor (further as „L‟); as a result quantity of labor demanded increases. This trick is useful in the short-run if a government wants to minimize the rate of unemployment, keeping in mind the stickiness of price level. Nonetheless, if such condition transforms to a long-run, then price level starts to adjust, and short-run aggregate supply (further as „SRAS‟) begins shifting up, thereby restoring the output produced. In the long-run, the increased demand for labor leads to an increase in output produced, so supply of those products increase. After these turns, the adjustment of price level brings to the increase in money demand, because goods and services are produced, and more money is needed to purchase all that stuff. As a result, increase in money demand changes the money market, so restored real interest rate shifts LM-curve, so that new, even higher real interest rate is obtained.
R FE LM2 LM1 PL LRAS
IS2 AD2 IS1 AD1 Y
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FE – Full employment LM – Liquidity Money curve IS – Investment-Savings curve PL – Price level SRAS – Short-run Aggregate Supply curve LRAS – Long-run Aggregate Supply curve AD – Aggregate Demand curve DL – Demand for Labor
Y Figure 2.
Logic here is in that in short-run fiscal policy increases output produced, demand for labor and real interest rate. In the long-run it brings to increase in price level and real interest rate, BUT Y and L are restored. B. National Bank of Kazakhstan and the Monetary Policy Monetary policy is the another type of ruling tools that are granted to government. As usual, monetary policy is performed by the Central Bank of a state. The National Bank of Kazakhstan plays the analogical role in the Republic of Kazakhstan. Mainly, monetary policy is all about money market, where the quantity of money supplied and demanded fluctuate. When there is an intersection of supply and demand curves, the equilibrium quantity of money is obtained that indicates the real interest rate in the economy. With the increase in money supply (i.e. if NBK starts printing money or domestic currency is being bought from foreign exchange markets) is observed, then there increases a quantity of money in the economy to a relative money demand. So, according
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to economic theory, the value of domestic currency falls, thereby depreciating it. As a result the overall price level is raised. Assuming that NBK increased nominal money supply (further as „MS‟), the following analysis can be made. Increase in MS leads to a decrease in real interest rate (R), that results in a shift of LM curve, because the situation in money market directly reflects the LM. The output produced increases in the short-run, because the increased MS means consumers are able to buy more goods and services, hereby increasing demand for them. Adopting to current circumstances, firms decide to hire more labor, as a result demand for labor increases. Again this policy is effective in the short-run, but in the long-run it is useless. Money are non-neutral only in short-run (i.e. concept of neutrality of money). Overall, concluding everything said above, both unemployment and inflation are unavoidable. There certainly exist some sort of unemployment, because of real wages. And there is certainly some type of inflation, because of depreciation of capital and some sort of underproduction and increase in the price level.
IV. ECONOMETRIC REGRESSION & PHILLIPS CURVE
So far the theory was a primary approach in this paper. Now, it is better to turn in some mathematical and empirical facts. According to the Agency of Statistics of the Republic of Kazakhstan, the general tendency of unemployment rate is downward sloping, whereas inflation rate is quiet interesting. Although during the last three years it was increasing, last changes in the monetary policy of the National Bank fully turned the
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rate backwards. The Phillips curve is the best measurement of the relationship of these two variables. Relying on the information, provided by the Agency of Statistics, the following regression analysis was obtained. Data range is between January 2006 until June 2009, resulting to 41 observations. Data provided are on a monthly basis, however the adjustment of unemployment rates were maintained because rates were supplied on a quarterly basis. Microsoft Excel 2007 was used in the econometric analysis. The equation ∆𝑖𝑛𝑓𝑡 = 𝛽0 + 𝛽1 𝑢𝑛𝑒𝑚𝑝𝑙1 + 𝜀𝑡 represents the Phillips curve. ∆𝑖𝑛𝑓𝑡 stands for change in the inflation rate in the period t; 𝜀𝑡 is the standard error that is described by the economists as a supply shock; 𝛽0 , 𝛽1 are the coefficients that describe the deviations of variables. In the equation, 𝛽0 is the y-intercept, whereas 𝛽1 is the slope of the line. So, the corresponding sample linear regression line is: 𝑦 = 𝑏0 + 𝑏1 𝑥1 + 𝑒𝑡 , where y is the monthly inflation rate; x1 is monthly adjusted unemployment rate. The results of the linear regression model for the periods between January 2006 and June 2009 are:
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Assuming that there are no supply shocks and other standard errors, the following Phillips function is obtained: ∆𝑖𝑛𝑓𝑡 = 54.74 + (−5.99)𝑢𝑛𝑒𝑚𝑝𝑙𝑡 𝑅 2 = 0.43; 𝑛 = 39 Negative slope of the line shows the appropriate negative relationship between inflation rate and unemployment rate. Two-tailed t-test of data with different variances. 1. Assuming that alpha is equal to 0.05, then H0: b1 = 0; H1: b2 is significant
(or useful). t0,025 = 2.024, df = 41-2 = 39. t-statistic is 6.95. 𝑡 > 𝑡0.025 , so b1 is statistically significant at alpha = 0.05 level of significance. 2. Alpha is the same, then H0: b2 = 0; H1: b2 is significant. t0,025 = 2.024, df =
= 41-2 = 39. t-statistic is -5.47. 𝑡 > 𝑡0.025 , so b2 is statistically significant at alpha = =0.05 level of significance.
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Test of usefulness of parameters give us true reasoning that all the parameters contribute to the model, therefore any of those parameters are non-negligible and nonexcludable. From the obtained model and the Phillips function, the following graph can be constructed.
40 Inflation Rate
30 Phillips Curve 20
0 -10 2 4 6 8 10 12
From the graph provided and according to the slope of the line, it can be suggested that the slope of the line is at the same time the marginal rate of substitution. In other words, one percent increase in the inflation rate leads to a 5.99 percent decrease in the unemployment rate.
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The natural rate of unemployment is found by the division of b0 by b1, implying that this ratio represents the portion of unemployment that is unavoidable. So, dividing 54.74 by 5.99 we get 9.14. That is the natural unemployment rate.
V. UNEMPLOYMENT & INFLATION: CORRELATION ANALYSIS
From the previous section, it is clear that these two variables are related to each other in a negative manner. Phillips curve beautifully shows this interrelationship. In addition to the previous method, there exist one more way defining that. The correlation analysis is the another route that helps to understand the issue. This analysis relies on variances of both variables. This analysis helps in clarifying how the change in one variable reflects the change in another one. Defining the mean variance of both inflation and unemployment, we find the Pearson‟s empirical correlation coefficient. Using the Microsoft Excel 2007, it is quiet easy and quick procedure, that gives the following report:
Inflation Inflation Unemployment 1 -0,658893546 Figure 5. Unemployment 1
Figure 5 shows that correlation coefficient is equal to -0.6589 that tells us about the fact that these two variables, inflation rate and unemployment rate, do not move together (i.e. negative relationship).
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VI. FORECASTING THE FUTURE
In order to construct a more or less reasonable forecast, it is better to deal with such instruments as Moving Averages and Exponential Smoothing. 1. Moving Average. Taking the interval n = 4, the inflation rate obtains a
quiet uncertain trend. However, according to the policy directions established by the National Bank, it is more possible that in future inflation rate is going to decrease.
Inflation Moving Average
15,0 Fact 10,0 Forecast
0,0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41
Same way is in the unemployment rate. With n = 4, the trend is pretty predictive, it is obvious that the tendency is downward sloping, so in the future probably the rate would keep decreasing.
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Unemployment Moving Average
9 8 7 6 5 Fact 4 3
1 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41
2. Exponential Smoothing. This approach does not much differ from the moving averages, but the main difference is that it takes into account the damping factor. Assuming that the damping factor is 0.5, following picture is illustrated:
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Inflationary Exponential Smoothing
15,0 Fact 10,0 Forecast
0,0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41
Here, it is more clearly visible that trend is going down. So, what about unemployment rate? Provided that w = 0.5, trend is:
Unemployment Exponential Smoothing
6 5 4 3 2 1 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 Fact Forecast
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Another method used for the forecasting is the Simple Linear Regression method. This approach is useful in generating an overall view on the situation, however it is not really sensible in short volatilities, so it is useful in the very long-run. After the appropriate data is collected, the following analysis is received.
Here, the objective SLR function is 𝑦 = 8.21 + 0.17𝑥1 . According to this function, the following graph is received.
Trend Analysis using Simple Linear Regression
25,0 20,0 15,0 Actual Rates of Inflation 10,0 5,0 0,0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 SLR Trend
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The same is with the unemployment. ANOVA looks like the following.
SLR function is 𝑦 = 7.98 − 0.04𝑥1 . Line is downward sloping, indicating that trend goes down. The graph is given.
Trend Analysis using Simple Linear Regression
9 8 7 6 5 4 3 2 Actual Rates of Unemployment SLR Trend
0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40
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VII. GENERAL INTERPRETATION OF RESULTS
The first econometric analysis was about the primary relationship between inflation and unemployment. Use of regression analysis helped to identify the Phillips curve, that represents the general overview on the economic situation in Kazakhstan. From the analysis, the Phillips function was discovered. It helped to build a graphical representation of fluctuations. Negative relationship between these two variables is shown by the slope of the curve (which is negative). It means that a percentage change in inflation leads to an appropriate percentage change in unemployment. Test of hypotheses about statistics helped to establish that coefficients of independent variables (unemployment) are not ignorable in the change of inflation. So, this test verifies that change in inflation immediately causes a change in unemployment. Correlation analysis was the another measurement of the relationship. It illustrates the same picture that increase in the inflation causes an inverse effect to the unemployment (causes decrease). Correlation analysis deals with the relationship of variances of both variables. Result shows that inflation and unemployment do not move in the same direction. Several methods were used in the measurement of future estimates of the variables. First one was the use of moving averages in the analysis. Although it is easy to define it, moving average represents quiet the same thing as the actual rates. It is significant in the very short run. Taking the average of three consequent rates, the forecast was obtained. Generally speaking, it supports the trend, implying that both inflation and unemployment rates are going to decrease in the very short run.
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Exponential smoothing is another tool that more or less clarifies the prediction. Despite the fact that it still does not generalize the analysis, it is quiet useful in the short run. From the analysis done with the Microsoft Excel, exponential smoothing shows and supports the suppositions done by the moving averages. The most useful way of all the three methods is the use of Simple Linear Regression in predicting the trend. This approach is useful in the long run, because it generalizes the data. Taking the data provided by the Agency of Statistics, the run of regression shows the linear function that represents the trend. This trend is controversial about inflation, whereas the unemployment predictions are supported by the previous data. Although inflation rate now is decreasing, the regression predicts the increase in the future. The policy run by the National Bank can be insignificant in the long run, however the situation can change if the policy is intensified or the very long period of time with the same situation is passed. The unemployment rate in Kazakhstan is decreasing, and the regression also predicts the support of trend, implying that in the future rate will approach to full employment.
All in all, this work and research made is mainly devoted to establish primary characteristics of inflation and unemployment, and their interrelationship amongst each other. Results from the analyses show that there is a negative relationship. Theory proposed by Phillips was confirmed in practice and the experience of the Republic of Kazakhstan. Facts and data provided by the Agency of Statistics certify that. Two
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approaches in forecasting provide sufficient evidence to claim that in short run the general tendency of changing the rates is going to be supported, while one of the approaches tell that in long run the inflation rate is going to increase.
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9A653B61BBA539DD&docid=178) 7. National Bank of Kazakhstan (NBK), (2009), Price Indices, (available online: http://www.nationalbank.kz/?uid=26EB6B15-D89D-F1C29A653B61BBA539DD&docid=170) 8. Agency of Statistics of the Republic of Kazakhstan, (2009), Kazakhstan In Figures, Labour, (available online: http://www.eng.stat.kz/digital/Labour/Pages/default.aspx) 9. Agency of Statistics of the Republic of Kazakhstan, (2009), Kazakhstan In Figures, Prices and Tariffs, (available online:
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10. Black F. (1985) “Noise”, The Journal of Finance, Vol. 41, No.3, Papers Proceedings of the Forty-Fourth Annual Meeting of the America Finance Association, NY, pp. 529-543. Available online: http://www.jstor.org/stable/2328481 11. Abel & Bernanke (2006), Macroeconomics
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