The Phillips Curve and the Negative Relationship between Inflation and Unemployment

Questions:

(a)  Explain whether there is a relationship between inflation and unemployment. Should government interfere and reduce inflation and unemployment? Provide real life examples. 

(b)  Using your home country as a case study outline and analyse inflation, unemployment and growth trends. Identify what range of the aggregate supply curve your country is operating in.

(c)  Explain how monetary policy can influence an economy, including the exchange rate and employment levels?

The macro economic variables named the inflation and the unemployment are the two important factors which determine the facet of the economy of a country. There is a negative relation prevails among the two macro economic variables named inflation and the unemployment. The negative relationships among the two variables are determined through the Phillips curve. The report likes to make some not on the Phillips curve and thus the relationship among the two variables named inflation and the unemployment. The report also concentrates on the factors related to the growth of the economy, the inflation of the economy and the unemployment scenario of the economy. The influence of the monetary policy also is enlisted in the report. 

The relationship or the trade-off among the two important variables of the economy named inflation and the unemployment was proposed by A.W. Phillips in the year of 1958. Through the help of the Phillips curve the relationship among the inflation and the unemployment can be demonstrated. According to the view of the Phillips curve there is an inverse relationship exists among the unemployment and the inflation. The simple process behind stating the inverse relationship among the unemployment and the inflation is that when the unemployment falls down in the market the workers put pressures for raising the wage level. The producers thus pass the rise in the wage level to the consumers and as a result of this the prices of the commodity gets rise. The formation of the theory of the Phillips curve depends on the Okun’s law where it was suggested that the relationship among the national output of an economy and the unemployment level of the economy (Sleeman, 2011). According to this law again there is an inverse relationship occurs between the national output of an economy and the unemployment level in an economy. The simple phenomenon behind the law states that lowering the unemployment level would raise the level of the national output of the households as the income of the households can be enhanced when the unemployment will slow down. On the basis of the theory proposed in the Okun’s Law the law regarding the Phillips curve has been introduced. The cycle starts here in the reduction of the level of unemployment in an economy which leads to the increase in the national output of the economy, because, the reduction in the unemployment in the economy leads to an increase in the wage rate of the employees and the workers (Galí, 201). The increase in the wage rate provides more in hand money to the consumers and the consumers can increase the consumption level in an economy. More money also enhances the demand level in the economy and the prices of the goods and service increase in this way.

Analysis of Inflation, Unemployment, and Growth Trends in a Case Study of the Home Country

                                                                                                                        Fig: Phillips Curve

                                                                                                                         Source: Author

It is depicted that the inflation rate is measured in the vertical axis of the diagram and the unemployment rate is measured in the horizontal axis of the diagram. When the unemployment rate in the economy stands for 2%, the inflation rate becomes 6% in the economy. When the inflation rate is 4% in the economy the unemployment rate becomes 7%. In both of the cases the negative relationship among the unemployment and the inflation signifies. The evidences can be drawn from the real historical data. For example, the evidences can be drawn from the US economy as the unemployment level in the economy rise from 5% to 11% which leads to a decrease in the inflation rate as the inflation rate decreases from 15% to 2.5% in the market. In the year of 2008, the rate of inflation falls down from 5% to 2% and thus the economy has observed a sharp rise in the level of unemployment in the economy which is 5% to 10% (Jain, et al, 2013). 

                                                                     Fig: The relationship among the inflation and the unemployment

                                                                                                    Source: (Louis, 2015)

The relationship among the unemployment and the inflation is occurred in the short-term period only and the consumers accept the raised wage rate as they perceive that the wage rate which is being offered to them is the real wage rate but, in reality the things are different in nature. The increasing wage rate which is offered to the households or the consumers are not the increase of the real wage rate and it is compensated with the increased price level in the economy and thus the economy finds the long term equilibrium in the position where the economy gets stable and the full employment condition occurs.

The Role of Government in Controlling Macroeconomic Variables

The government intervene through undertaking the macro-economic policies for achieving the full employment condition in the economy. Sometimes it is observed that the government intervention to increase the wage level can put extra pressures on the employers. The unemployment in the market occurs when the labour costs gets rise over the productivity of the labour. The government is considered as the extraneous farce whose function in the labour market is determined through the sale of the labour and the purchase of the labour. In the recent age the government has delegated some power to the trade Union members for putting pressure for wage hike in the economy (Bosworth, et al, 2007). The trade union has the power to hamper the productivity of the organizations also. The intervention of the government can be observed in two different scenarios; one in which the government would put pressure to increase the cost of the labour in the market and the other through which the productivity is hampered through the implementation of the taxation and other regularity policies. Sometimes the political pressure or the intervention of the government increases the labour cost beyond the productivity of the labours. But, it is also evident that during the time of recession the developed countries including UK and USA have gone through a major changes and the intervention of the government has helped to stabilize the economy when the government has focused on the specific measures on the monetary and the fiscal policy related tools (Ghosh and Chandrasekhar, 2009).

The Indian economy has placed itself in the world’s biggest economy according to the point of view of the GDP growth of the country. The Indian economy is known to be a growing economy and the economic growth in the economy has opened the horizon of producing a larger amount of goods and services in the economy. The Indian economy has shown a good performance in terms of growth in the year 2010-2011 and in this financial year the fiscal deficit of the economy also reduced to a certain extent. The financial year 2010-2011 did observe the economic growth rate accounts for 8.4% which is sound in nature and the fiscal deficit of the particular year stands for 4.7% which was reduced from 6.4% (Chowdhury, 2011). The Economy did face a sound performance in the current account deficit of the country. After the sharp growth of the year 2010-2011 the economy faced a downfall in terms of the fall in the GDP growth of the country. From, the year of 2011 onwards the economy did face a sluggish growth and it is continuing till now (Bhatt, 2011).

                                                                           Fig: The quarterly figure of growth of Indian economy

                                                                        Source: World Development indicators (World Bank data)

The rise in the GDP growth rate occurred in the year of 2005 as the year has observed the GDP rate of 9%. The year 2012 and 2013 have observed the sluggish growth rate as the growth rate for these two years stand for 5%. The other variables including the unemployment, the fiscal deficit and also the inflation of the country are happened due to the sluggish growth nature of the economy of India. The unemployment and the inflation both are the rising factors for the economy of India. The unemployment of the country India is considered as the number of people in the economy divided by the number of people who are searching for a job. The unemployment scenario of the Indian market is poor in nature and the

                                                                        Fig: The unemployment and the inflation scenario of India

                                                                                     Source: Labour force Statistics of India

Unemployment occurs in the Indian economy just after the independence takes place in the Indian economy. The unemployment is a rising decease in the economy as with the growing population of the economy, the demand for the jobs are also increasing in the economy. Indian economy faces various types of unemployment (Misra and Puri, 2005). During the time of recession the economy did observe a downturn in the rate of employment which is basically known as the cyclical unemployment which occurs due to the short of aggregate demand in the economy. The economy also faces the structural unemployment and the seasonal unemployment in the context of the country’s economy (Kapila,  2009). The structural unemployment happens when there is a shortfall in the progress in any particular sector and the seasonal unemployment happens mainly in the regional sector of India. The frictional unemployment is another reason in the Indian economy to occur the inflation in the market as the frictional unemployment happens because though there are ample of people want to work in specific sectors but, the skills of the workers do not match with the required skills of the employers.

The Indian economy on the other hand is observing a rising trend in the inflation and many factors are responsible for the rising trend of the inflation. The pub expenditure is a reason for the enhancement of the inflation in India and the expenditure of the consumers are also increasing in nature (Bosworth, et al, 2007). The rise in the public expenditure happens in the non-development purpose also which increases the level of inflation in the country. The non-development increase in the public expenditure puts huge pressure on the fiscal deficit condition of the country. For meet up the requirement of the fiscal deficit of the country the Indian government goes for the borrowing from the international market. The external borrowing done by the government can raise the rate of interest in the country and which in-turn can influence the output level of the country and also the level of investment of the country. The cyclical effect would influence the level of inflation in the framework of the country. The agricultural products also goes through the phenomenon of the seasonal effect and the agricultural products go through both the draughts and the flood scenario in the market. The flood and the draught in the market enhances the prices of the agricultural products and the rise in the wage level in the agricultural market also pushes the general price level in the agricultural products as the producers want to pass down the rising effect of the wage to the consumers. The Indian population always gets rise and the increasing trend of the Indian population also acts as a reason for the unemployment in the country. The demand of the employment is not enough as the supply of the labour force is very high in the economy.

The aggregate supply is considered as the curve which accounts the overall supply of the nation within a given time period.

                                                                                     Fig: Three ranges of aggregate supply

                                                                                        Source: (Leduc and Liu, 2012) 

The above figures clearly depicts that three different ranges are existing in the aggregate supply curve and a nation can observe or face any of the three different range of the aggregate supply in the economy. The first range is known as the classical range as the first range observes the full employment situation in the economy. The vertical range or the straight range signifies the classical range of the full employment situation and the horizontal range which signifies the position between 0 to Y_k signifies the Keynesian range of aggregate supply. The range of the aggregate supply which belongs in between of the classical range and the Keynesian range is called as the Intermediate range. The full employment situation can be occurred when the unemployment except the frictional unemployment all other kinds of unemployment can be removed from the context of the economy of a country. In the full employment situation the economy gets the desired output and the output in the economy always requires being remaining same but, there is provision in the economy to change the price level. The Keynesian range on the other hand signifies the range which is possible when the economy is going through bad phase especially, a recession or a depression (Mohan, 2009). During the time of full employment the economy must face the inflation but, while operating in the Keynesian range the economy must face the high level of unemployment. Due to the high level of unemployment the economy can try to achieve the full employment situation by adjusting the level of output. The level of output can be increased by not adjusting the price level of the economy. Due to the unemployment situation the output level in the economy can be increased without adjusting the price level of the economy. The intermediary range refers to that range in which the price level in the economy and the output level in the economy can be influenced for the purpose of achievement of the full employment in the economy (Fahimnia,  et al, 2013). The Indian economy is going through the phase of the Keynesian economy as the recession has hit the economy to a large extent and the recession has raised the unemployment in the economy. To recover the economy the output level in the economy is being increased through the creation of the additional demand in the economy without changing the price level of the economy (Subbarao, 2008). 

The monetary policy is known to be a controller of the excess money supply in the economy. The main objective of the monetary policy is to reduce the excess presence of the money in the market because; the excess presence of the money in the market raises the level of inflation in the market. The inflation in the market can be influenced through the usage of the monetary policy in the market as the reduction in the rates of the Banks or the rate of interest in the economy can lead to a high demand for the goods and the services in the economy. The decrease in the Bank rates increase the supply of money within the Banking system of an economy and the reduction of the rate of interest affects the level of investment and the output level of the economy. The strong investment in the market also raises the demand for the workers and the level of wages is thus increased in the economy. The good performance of the economy also increases the expectation o the economy which again increases the level of inflation in the market. The expansionary monetary policy is used to increase the level of growth in the economy and in the other hand the discretionary monetary policy helps to reduce the inflation in the market. The basic objective of the monetary policy is to establish the stability in the market and the employment level of the economy is directly influenced by the monetary policy of that country. For example, it can be said that when the rate of interest is being reduced by the monetary authority and the demand for the goods and the services increase and the level of investment in the country also increases. The increased level of investment also increases the level of the employment in the country and this is the way through which the monetary policy influences the employment level of a country. There are various implications to the effect of monitory policies expansion phenomenon and those are like involved within the exchange rate, current and financial account details. If the monetary policy is restrictive in nature, the result is comprehended in the opposite direction with the stronger financial account intimation and feeble current account attribution with the unbalanced trade optimization. The integration of easy monetary policies will help to intrigue the sequence of events and with respect to the income effect in the countries:

The GDP in domestic phenomenon will rise and this will be effective in the demand increment for imports. This will again affect the depreciation of the current account.

Then there will be increase in purchased imports and those are to be also appreciated to the domestic to foreign currency conversion and with implications to those, the domestic country’s exchange rate will decrease.

There will be negative impact by the government intervention and those are also resulted in the surplus of the financial accounts. Thus the proper summations of both the accounts are tended towards zero and as there will be increase in imports activities, the foreigners can have a surplus of that particular nation’s currency and money. The foreigners are most of the time investing those currencies to the domestic country’s assets and not on to purchase the country’s exports. This phenomenon can be observed within the countries like Japan and China for investing in US treasuries. The foreign travellers can often get the better rates and return on the values of domestic currency as the exchange rate is decreasing comparatively to their own currency.

Thus the immediate effect with the expansionary monetary policies on the income variable is to be trended to the lower currency exchange rate in the domestic rate. This also implied to deteriorate the current account with increment in the financial account. The restrictive monetary policies also intended to cause the opposite effect due to their adverse income effect. This is involved in current account improvement and financial account weakening with increment in currency exchange rate domestically. 

Conclusion

The relationship among the inflation and the unemployment is negative in nature and the government intervenes in influencing the inflation or the rate of unemployment for achieving the full employment in the economy. The Indian economy is a growing economy though it is going through a sluggish nature of growth in the economy. The huge population is the reason for the unemployment in the economy and the economy also faces the problem of inflation for a long term. The monetary policy keeps huge influence in the employment, inflation and in the exchange rate of the economy.

Reference 

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