Phillips Curve - Learn How Employment and Inflation are Related
Abstract. This paper provides analysis of the relationship between unemployment , inflation and economic growth in Nigeria: SR and LR tradeoff between inflation and unemployment (Phillips Curve) shows the relationship between the inflation rate and the unemployment rate. The Natural Rate of Unemployment and the Phillips Curve. The Phillips curve, based on the data above, shows a negative relation between inflation and.
Trade-Off between Inflation and Unemployment: The Phillips Curve
According to Friedman, there is only one long run, i. Friedman then correctly predicted that, in the upcoming years afterboth inflation and unemployment would increase. Phillips curve involves a disagreement among the investigators about whether unemployment causes inflation or inflation causes unemployment. Fiscal and monetary policies can be used to attain full employment at the cost of high inflation or lower inflation at the cost of high unemployment respectively. Recently the Federal Reserve has kept the interest rates unchanged citing the low inflation in the US.
But shockingly, this relationship has failed in the context of India. Recently, there was news that 23 lakh candidates have applied for the post of peons in Uttar Pradesh. The candidates not only included graduates but also 2. The study is based on unbalance panel data.
The result shows that there is negative relationship between inflation and unemployment rate in SAARC countries. Dholakia, IIM Ahmadabad Julythe study attempts to answer the question whether a tradeoff exists between inflation and unemployment in India. He empirically estimate the Phillips curve for India, subsequently incorporate the extended part of the Phillips curve, and find that a tradeoff does exist in the choice between inflation and unemployment in the short-run in the economy.
The findings show that the conventional Phillips remains absent even on account of controlling for supply shocks, but clearly emerges as he incorporate the extended part into the basic Phillips curve framework.INFLATION & UNEMPLOYMENT
The results of the extended Phillips curve show that the speed of recovery as captured by the extended part is an important factor in explaining inflation and the strategy for dis-inflation and recovery from adverse supply shocks.
Vashist, the study brings out the fact that the past studies have found mixed evidence about the shape of the Phillips curve from being horizontal to vertical.
This shows that any policy aimed at rapid economy growth or recovery will not result in the rise of inflation. Rather it should reduce the involuntary unemployment. While, on the other hand, a slow recovery or lower growth rate may aggravate inflationary tendency in the economy.
In sum, it can be said that India can reduce involuntary unemployment through faster and inclusive economic growth without facing the problem of inflation.
Muhammad Auwal Abubakar et at. To analyse the objective the research study used ordinary least square method, Augument dickey fuller techniques and Granger causality test. The study found that the unemployment is positively and significantly effects the wage rate where as inflation rate is affecting the wage rate positively but not significantly. The result of Unit root revealed that both the variables are stationary. The results of Granger causality test suggests that unemployment Granger causes wage rates but not inflation.
Kirandeep Kaur, the study analyse the relationship between unemployment, exchange rate, Growth rate and inflation rate from period with the use of simple linear regression analysis. The study found that there is negative and significant impact of inflation rate and exchange rate on unemployment where as the GDP growth rate effect negatively to unemployment but it is not significant.
The study found that there is trade off between unemployment and inflation but more research work is needed for further analysis of these variables. It has adverse impact on income distribution. A price rise tends to benefit some and harm others. While for some income earners, income rises more rapidly than prices during inflation, for many others just the opposite is true. Those who have fixed incomes are seriously affected as the real income decline during periods of inflation.
Inflation also has an effect on lending and savings. Inflation benefits the borrowers at the expense of the lenders and savers. It has also adverse effects on foreign trade. The competitiveness of a country may be seriously affected.
- The Relationship Between Inflation and Unemployment
Factors affecting the inflation 1. Increase in Money Supply: Inflation is caused by an increase in the supply of money which leads to increase in aggregate demand. The higher the growth rate of the nominal money supply, the higher is the rate of inflation. Increase in Disposable Income: When the disposable income of the people increases, it raises their demand for goods and services.
Disposable income may increase with the rise in national income or reduction in taxes or reduction in the saving of the people. Increase in Public Expenditure: Government activities have been expanding much with the result that government expenditure has also been increasing at a phenomenal rate, thereby raising aggregate demand for goods and services 4. All these developments resulted in the emergence of newer theories and, hence, economic policies.
Anyway, the policy conclusions generated by the Phillips Curve lost relevance in the s and s when both inflation and unemployment rose. This suggests the disappearance of trade-off between inflation and unemployment as envisaged by A. Monetary economist headed by Milton Friedman challenged the concept of stable relationship between inflation and unemployment as shown in Fig.
According to Friedman such trade-off— negative sloping Phillips Curve—can exist in the short run at least, but not in the long run. In the short run, Phillips Curve may shift either in the upward or downward direction as the relationship between these two macroeconomic variables is not stable. On the other hand, in the long run, according to Friedman, no trade-off exists between inflation and unemployment. That is why a trade-off relationship emerges.
But, in the long run, actual and expected price changes become equal as expectation regarding price changes tend to become rational. The government adopts expansionary fiscal policy because of political pressures and cuts taxes. Show how shifts in the AD curve will affect the Phillips curve. Assume long run equilibrium. The government increases spending to get unemployment and production back to its natural rate. Role of Expectations Rational Expectations — people will adjust their behavior to expectations of inflation.
Shifts in AD causes movement along the short-run Phillips curve Shifts to the right cause inflation to increase and unemployment to decrease Shifts to the left cause inflation to decrease and unemployment to increase 16 Shifts in Phillips Curve: Assume an upward-sloping aggregate supply curve.
Trade-Off between Inflation and Unemployment: The Phillips Curve
On the graph from part ashow how the increased military expenditures affect the following in the short run. Assume that the United States economy is in long-run equilibrium with an expected inflation rate of 6 percent and an unemployment rate of 5 percent. The president of Southland is receiving advice from two economic advisers—Kohelis and Raymond—about how best to reduce unemployment in Southland.
Label the initial equilibrium from part a as point A, and the new equilibrium resulting from the decrease in taxes as point B. That is, describe the movements along a given curve or the direction of the shift in the curve. An increase in expected inflation causes people to demand higher wages causing firms to decrease production Shifts short-run Phillips curve to the right upward.
An increase in the price of imported oil An increase in the money supply causing unexpected inflation Movement along and up the short-run Phillips curve.