Inflation and Unemployment

Posted: August 27th, 2021

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Inflation and Unemployment

Unemployment and inflation are macroeconomic factors that significantly impact global economic variables in a country in the short and long term, as described by the Philips curve. Unemployment is a major global economic problem almost evident in every country because of ample labor supply with limited demand market (Gordon, Robert, and Gordon, 117). The unemployment rate indicates the number of unemployed individuals in a nation compared to the total labor force. Therefore, the higher the number of unemployed persons in a country, the higher the unemployment rate. Thus, such a high unemployment rate can be attributed to low demand, economic structure, or seasonality of employment opportunities, among other factors like technological disruptions.

Contrarily, inflation is the persistent increase in the prices of commodities. The rate of inflation is the variations in the general price level of commodities in an economy. Inflation can be demand-pull or cost-push inflation (Gordon, Robert, and Gordon, 123). Demand-pull inflation occurs due to high demand in industry, increasing the general prices of the commodities. This is attributed to a rise in money supply, net exports, and expansionary fiscal policies.Cost-push inflation occurs because of constant increase input costs, resulting to subsequent increase in prices. For instance, anincrease inraw materials costs may increaseprices for final consumers. Equally, the cost-push inflation is caused by economic factors such as high import costs and an increase in employees’ salaries without a subsequent increase in the output. Therefore, this paper examines the relationship between inflation and unemployment. Also, the paper provides an empirical analysis of inflation and unemployment besides offering trend analysis for the two macroeconomic indicators.

Relationship between Unemployment and Inflation

The relation between inflation and unemployment is best exemplified by the Philips curve that explains the short and long-run relationship. The long-run model was developed in the 1970s to indicate the long-term relationship between inflation and unemployment levels, a vertical line to the natural unemployment rate (Gordon, Robert, and Gordon, 127). In the long run, unemployment leads to increases with demand, creating an inflationary gap. However, at equilibrium of unemployment and deflationary level, inflation is expected to be at minimum (Gordon, Robert, and Gordon, 127). Therefore, inflation can only rise when there are total or high employment levels in the industry. The reason is that during whole employment levels, the economy can only experience a slight possibility of an increased money supply to the national output.

Point A is the initial inflation and unemployment level. This shifts to point B, which is the unstable equilibrium. It occurs following government push for expansionary policies. As illustrated by a shift of the aggregate demand curve to the right, there is an increase in inflation. As aggregate demand rises, more employees are hired to increase output in response to the rising demand, thereby decreasing unemployment levels. However, the higher inflation levels change the employees’ expectations on the future inflation, thus shifting the short-run curve from an unsteady equilibrium point B to a more balanced point C in the right. Thus, at this point, point C’s unemployment rate has bounced back to its natural levels, but the inflation rates remain higher than their initial levels.

Figure 1: Long-run Phillips Curve

From Figure 1, the short-run curve indicates that inflation and unemployment levels have an inverse relationship. The modelwas developed in the 1960s, but some loopholes were established, showing that economies can experience stagflation. Stagflation can be explained by stagnant growth rates in the economy, unemployment levels, recession, or high unemployment and inflation rates simultaneously (Gordon, Robert, and Gordon, 143). Figure 2 below illustrates that inflation and unemployment levels are inversely related, and a decrease in unemployment levels leads to a subsequent increase in the inflation rates. However, the relationship is not linear, and as observed in the graphical representation, the short-run curve depicts an L-shape. When the inflation rate is 2%, the unemployment rate is 5%, and when the inflation rate rises to 6%, the unemployment rate decreases to 3% (Figure 2). Therefore, there is a tradeoff between unemployment and inflation rates in the short run as there is an expected inflation level towards the given unemployment levels; thus, the short-run curve slopes downwards. Additionally, the short-run salaries are not renegotiated because of the money illusion factor, and increases in money growth and supply do not reflect the same wage contracts.

Figure 2: Short-run Phillips Curve

Empirical Analysis

The data used in the empirical analysis is obtained from the U.S bureau of labor statistics on economic indicators. The data covers the unemployment and inflation rates for the period between 1980 and 2015. Additionally, the unemployment rate is the percentage of unemployed youths in the national estimate between the labor force ages 15 and 24. The empiricalanalysis will be based on U.S.A’s actual data to determine the relationship between unemployment and inflation rates using descriptive statistics.

Figure 3: U.S inflation- employment for period 1980 to 2015

From Figure 3, it can be observed that there is an inverse tradeoff relationship between inflation and unemployment from 1980 to 1983. An increase in inflation leads to a decrease in employment levels.  The economy experienced stagflation between 1986 and 1989, as there was an increase in both inflation and employment levels. Furthermore, as evidenced in the graph, the economy marked a tradeoff between inflation and unemployment for ten years between 1989 and 1999. This is demonstrated by the inverse relationship between the two macroeconomic indicators. The changes are attributed to a rise in the money supply, leading to a spiral wage inflation spiral, reducing unemployment levels. Therefore, reducing the money supply in the economyachieves low inflation, temporarily improving the unemployment levels.

            Additionally, the tradeoffs improved in the early 2000s due to low global inflation and less unemployment in the county without a subsequent inflation increase. This led to a period of stability in the economy. However, in 2008, the economy experienced an increase in unemployment level and a decline in the inflation rates due to the global financial crises, recession, and oil price reduction. Further, the period between 1985 and 2007 witnessed stagflation as shown in the graph and divided into three sub-periods, the downward, steep, and upward relationship in inflation and unemployment. The economy experienced a downward trend between 1980 and 2000. The curve was steep in the 1980s and shallow in the 2000s, and an upward trend in the 1990s. However, there was higher unemployment and inflation between 2010 and 2015 due to cost-push inflationary pressures. Conversely, the upward relationship contradicts the Phillips curve of a tradeoff in unemployment levels and inflation rates, signifying stagflation. Therefore, the economy experienced low inflation and employment rates in the 1990s and 2000s due to increased competition in evolving U.S. industries. The industrial competition barred the producers from increasing prices. Thus, with successful monetary policies, there was a reduction in people’s expectations on future inflation, labor forces demographic shifts, and changes in employees’ productivity.

Descriptive Statistics

The descriptivestatistics indicate the relation between inflation and unemployment by showing the frequency, central tendency, variation, and position, as shown in Table 1. The inflation’s mean is 3.37%, and unemployment’s mean is 13.13% for the period with a variance of 0.06%for inflation and employment. The data analysis shows a positive correlation of 3.79% and a standard deviation of 0.00%. The 3^rdQuartile is 3.77% inflation and 14.05% unemployment.

Table 1: Results of Descriptive statistics

Year	Inflation	Unemployment
1980	13.51%	13.80%
1981	10.32%	14.90%
1982	6.16%	17.80%
1983	3.21%	17.20%
1984	4.32%	13.90%
1985	3.56%	13.60%
1986	1.86%	13.30%
1987	3.74%	12.20%
1988	4.01%	11.00%
1989	4.83%	10.90%
1990	5.40%	12.00%
1991	4.23%	13.40%
1992	3.03%	14.20%
1993	2.95%	13.40%
1994	2.61%	12.50%
1995	2.81%	12.10%
1996	2.93%	12.00%
1997	2.34%	11.30%
1998	1.55%	10.40%
1999	2.19%	9.90%
2000	3.38%	9.30%
2001	2.83%	10.60%
2002	1.59%	12.00%
2003	2.27%	12.40%
2004	2.68%	11.90%
2005	3.39%	11.30%
2006	3.23%	10.50%
2007	2.85%	10.50%
2008	3.84%	12.90%
2009	-0.36%	17.60%
2010	1.64%	18.40%
2011	3.16%	17.30%
2012	2.07%	16.20%
2013	1.46%	15.50%
2014	1.62%	13.40%
2015	0.12%	13.45%
Mean	3.37%	13.13%
Variance	0.06%	0.06%
Correlation	3.79%	3.16%
Standard deviation	0.00%	2.33%
3rd Quartile	3.77%	14.05%

Conclusion

Unemployment levels and inflation are essential macroeconomic techniques. Hence, their relationship is viable, as best explained by the Phillips Curve in the long and short run. The long-run curve was developed to deal with the short-run restrictions and loopholes associated with money illusion and increased wages in the economy. The long-run curve gives a vertical line to the natural employment levels as it reflects a situation of money illusion and wage increases. Therefore, it is crucial to examine the inflation rates and unemployment as natural levels to understand any nation’s economic situation. This would help to draw significant macroeconomic trends on a country’s economy. Additionally, the unemployment level in an economy should be low to enhance economic growth in a country. Besides, low unemployment levels ensure a strong money supply, high purchasing power, and low inflation rates. Hence, unemployment and inflation have a strong correlation, as illustrated by the Phillips curve, depicting macroeconomic trends for maintaining a healthy economic situation.

Works Cited

Gordon, Robert J., and Robert J. Gordon. Productivity Growth, Inflation, and Unemployment: The Collected Essays of Robert J. Gordon. Cambridge UP, 2004.