Essay on the Relationship Between Unemployment and Inflation


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Unemployment and Inflation

Pages: 7 Words: 1806


The relationship between unemployment and inflation is inverse. It shows that the rise in the unemployment rate increases a nation's inflation according to Philips' curve. However, the curve shows that the relationship between unemployment and inflation is non-linear (Gordon, 2018). The first idea regarding the Philips curve was in the proposition by A.W Philips, who was an economist in 1958. He traced changes in wage and those of unemployment in his original paper in Great Britain from 1861 to 1957. He found out that there was a relationship between unemployment and wages (Goldberg, 2018). The relationship was inverse but stable. The correlation between the changes in wage and unemployment played a very crucial role in the economies of Great Britain and other industrial nations. The relationship was later expanded and transformed in 1960 by two wage economists. Robert Solow and Paul Samuelson transformed the relationship between the wage rates and unemployment into a new one (Sayeed et al., 2019). The new relationship was between inflation and unemployment, whose reflection was from Philips' discovery and work.

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In the relationship between inflation and unemployment, wages are the enormous part of prices, and rather than the changes of wage. He affirms that inflation has an indirect link with unemployment (Russell & Rambacussing, 2019). The Philips curve theory seemed predictable and stable. The relationship between inflation and unemployment was modelled fairly well by the data from the 1960s (Sayeed et at., 2019). The monetary and fiscal policies are outcomes of the potential economic policies that were offered by the Philips curve. The policies could be applied to establish full employment at a higher price level cost or to reduce inflation at the cost of reduced employment rates. However, when the Philips curve was adopted by governments regulate inflation and the rates of unemployment, the relationship was not fruitful. Therefore, from the 1970s onwards, the data did not adopt the trend of the Philips curve (Goldberg, 2018). Both the rate of inflation and that of unemployment were above the Philips curve for many years. The Philips curve could thus not predict it. The phenomenon is stagflation (Snower & Tesfaselassie, 2017). The ultimate result was that the Philips curve displayed proof of instability, therefore not suitable to be adopted in the purposes of policies.

The Distinction between the Short-run and the Long-run

Short-run analysis of microeconomics is a duration of the stickiness of wages as well as some other prices. On the other hand, Long-run refers to a period when full wage and flexibility of prices, as well as adjustment of markets, has been attained (Snower & Tesfaselassie, 2017). At the Long-run, the economy is often at the natural and stable level of potential output and employment. The Short-run in the microeconomic analysis is a time when wages alongside other prices do not conform to the alterations in the economic conditions. In some markets, wages and other prices may not be in compliance on time with the maintenance of the market equilibriums, as the conditions of the economy change. A sticky-price is that that does not quickly adjust to its level of equilibrium, leading to sustained durations of surplus or shortage. The stickiness of wage and price bars the economy from attaining its natural state of potential output and employment. However, the Long-run in the analysis of microeconomy is a time when prices inclusive of wages are flexible. In the long-run, the rates of employment move to its natural level and true Gross Domestic Product to its potential (Gordon, 2018).

The relationship between the rate of unemployment and inflation are different in the short-run and the Long-run. In the Short-run, the rate of unemployment increases as well as the magnitude of inflation. The reason being is that, during the Short-run, a period of the stickiness of wages and other prices is experienced (Goldberg, 2018). To the contrary, the rates of unemployment in the Long-run reduces just like inflation. It is because, in the Long-run, a period of full wage and the flexibility of other prices is under experience, thus the adjustments of the market equilibriums. Generally, the levels of unemployment and inflation in Short-run directly opposes their same levels in the Long-run. Therefore, when the rate of unemployment falls below its natural rate, there is an automatic acceleration of inflation. On the other hand, when the rate of unemployment falls above its natural level, there is an automatic deceleration of inflation (Snower & Tesfaselasie, 2017). However, the balance of unemployment with its natural rate stabilizes inflation and makes it non-accelerating.

A 20-year Assessment and Analysis of the U.S. Unemployment and Inflation Data Based on the Philips' Curve

According to the unemployment and inflation data of the United States of America for the past 20 years, the rate of unemployment has been reducing (Russell & Rambacussing, 2019). During the early 2000s, the rate of unemployment in the nation stood below 5.6 % but was reduced even further to a rate of 3.7 % according to the unemployment data report released in 2019 (Sayeed et al., 2019). Consequently, the inflation rate in the nation has been below 3% for the past 20 years (Goldgerg, 2018). The current U.S unemployment and inflation data do not confirm the Short-run Philips curve. The data disapproves Short-run Philip curve because the rate of unemployment, as well as that of inflation, has been reducing for the past 20 years. According to the Philips curve, a nation's data regarding the unemployment rate and inflation approves the Short-run if the nation experiences a period of the stickiness of wages and other prices. The characteristics of the Short-run of Philips curve is associated with the overtime increase of unemployment rate and inflation, which is not the case for the United States of America. Instead, the unemployment and inflation data report of the nation for the past 20 years has been complying with the Long-run of the Philips curve. It is because, the period is characterized by a constant decrease in unemployment rates and inflation. Thus, constant reduction of the wage and price stickiness.

Evaluation of Philips Curve on its Resolutions to the Present and Future Cases of Unemployment and Inflation

The potential outcomes of the economic policies, like the monetary and fiscal policies, are the products of the Philips curve (Gordon, 2018). However, it cannot be adopted in the resolution of the current and future issues regarding unemployment and inflation validly and reliably. The Philips curve cannot control and regulate the relationship between the rates of unemployment and inflation. The crucial relationship can, therefore, fall apart like it did when the Philips curve was adopted by many governments globally before the 1970s (Russell & Rambacussing, 2019). The reason being is that it could not and still cannot control and define the present and the future rates of inflation and unemployment that are higher than its prediction. It is therefore proved to be unstable, and thus not suitable for policy since it leads to stagflation. A nation experiences stagflation when its economy undergoes a stagnant growth or improvement, high inflation of price and increased rates of unemployment. The United States of America did not experience stagflation until in the 1970s when the escalating rates of unemployment did not match with the reducing inflation (Goldgerg, 2018). From 1973 to 1975, the economy of the U.S. posted six consecutive quarters of a reducing Gross Domestic Product and simultaneously had its inflation tripled (Russell & Rambacussing, 2019).

The stagflation phenomenon and the Philips curve breakdown can make the economists take a deeper look at the functions of expectations in the relationship between inflation and unemployment. Since consumers and workers can influence their expectations concerning the inflation rates of the future based on the present ones and unemployment, can only hold the short run. When the central banks raise inflation with an attempt of reducing the rate of unemployment, it has chances of causing the Short-run of the Philips curve to generate an initial shift. However, as the consumer and worker expectations concerning inflation to put up with the resultant environment, there can be an outward shift in the Long-run of the Philips curve. A scenario imagined being revolving around the case of the natural unemployment rate. The rate is crucially in the representation of the normal rate of institutional and frictional unemployment in a country's economy. So, if the expectations can conform to the alterations in the rates of inflation in the Long-run, then its portion on the Philips curve resembles the monetary policy. The policy either reduces or increases the inflation rate after the expectations of the market have worked themselves out.

During the stagflation periods, consumers and workers may even begin to anticipate for inflations rates rationally, to rise from the moment they will know that there is a plan to adopt the monetary policy of expansion by the monetary authority. The consequence is the outward shifting in the Short-run of the Philips curve even before the execution of the expansionary monetary policy, to pose little effect on reducing unemployment by the short-run policy. Consequently, the Short-run of the Philips curve ends up being a vertical line at the natural unemployment rate (Sayeed et al., 2019).

Recommendations to the Current U.S. Unemployment and Inflation as a Policymaker

The American government has achieved tremendous progress concerning the reduced rates of unemployment and improved economy for the past 20 years. However, the creation of jobs and the security of the U.S. economy is the number one recommendation to shape the nation's few persistent issues of unemployment and inflation (Gordon, 2018). The American government should uphold the aggregate demand at the standards that are in uniformity with full employment of the macroeconomy. As a policymaker, the essential role is making sure that the aggregate demand like household spending, government and businesses at the level of the nation is strong enough to aid sustainable standards of employment or the full employment of the macroeconomy. The management of the aggregate demand is the role of the policy of macroeconomy, especially, monetary, fiscal and the policies of exchange rates. In case the aggregate demand is vastly lowered, there cannot be even a single strategy of creating jobs that can effectively be fruitful until the challenge is in remedy.

The resultant employment advancement should be vastly shared. The complementary policies should be in enaction to facilitate the widest spread of the maximum sustainable aggregate demand level throughout the nation as possible, across communities, regions and workers. It can ensure that any aggregate demand level is as job-intensive as possible by relaying policies targeting the pursuant of a decrease in average working hours. Measures geared towards minimizing working hours are inclusive of paid vacations and family and medical leave. They can also include permission of work-sharing subsidies in the insurance system of unemployment, as well as the preservation of the latest boosts in the threshold of salary below that the hourly employees are granted automatic qualification for overtime payment. To facilitate the uniform spread of aggregate demand level in a maximized fashion.

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