INTRODUCTION

Inflation and Unemployment are two important concepts in macroeconomics which have
implications on the economy of a country. In order to reduce their effect on an economy, it is
important to understand the relationship between them. According to Phillips Curve, inflation
and rate of unemployment are inversely related, in other words there exists a trade-off
between inflation and unemployment. Efforts to reduce unemployment result in increased
inflation and vice-versa. Understanding the trade-off and making a choice has policy
implications while handling supply shocks, bringing inflation to a stable level and creating
strategies for the growth of the economy.

OBJECTIVE OF THE STUDY

The objective of this report is
 To study the inflation and unemployment in Indian economy over the years,
 To analyze the trade-off between inflation and unemployment.

SCOPE
Based on the data related to inflation and unemployment in India, it is established that
Inflation and unemployment in India are inversely related in the short term. It is also
observed that the government will not be able to reduce the unemployment rate for an
extended period by increasing wage rates.

BACKGROUND

What is Unemployment?
Unemployment is a situation when a person actively searches for a job and is unable to find
work. Unemployment indicates the health of the economy. 
The unemployment rate is the most frequent measure of unemployment. The unemployment
rate is the number of people unemployed divided by the working population or people
working under labour force.
Unemployment rate = (Unemployed Workers / Total labour force) × 100
National Sample Survey Organization (NSSO) defines employment and unemployment on
the following activity statuses of an individual. NSSO, an organization under MoSPI –
Ministry of Statistics and Programme Implementation measures India’s unemployment on
three approaches:

1. Daily Status Approach: unemployment status of a person under this approach is

measured for each day in a reference week. A person having no gainful work even for
one hour in a day is described as unemployed for that day.
 2. Weekly Status Approach: This approach highlights the record of those persons who
did not have gainful work or were unemployed even for an hour on any day of the
week preceding the date of the survey.
3. Usual Status Approach: This gives the estimates of those persons who were
unemployed or had no gainful work for a major time during the 365 days.

Types of Unemployment in India

In India, there are seven types of unemployment. The types of unemployment are discussed
below:

1. Disguised Unemployment: This is a type of unemployment where people employed

are more than actually needed. Disguised unemployment is generally traced in
unorganised sectors or the agricultural sectors.
2. Structural Unemployment: This unemployment arises when there is a mismatch
between the worker’s skills and availability of jobs in the market. Many people in
India do not get job matching to their skills or due to lack of required skills they do
not get jobs and because of poor education level, it becomes important to provide
them related training. 
3. Seasonal Unemployment: That situation of unemployment when people do not have
work during certain seasons of the year such as labourers in India rarely have
occupation throughout the year.
4. Vulnerable Unemployment: People are deemed unemployed under this
unemployment. People are employed but informally i.e. without proper job contracts
and thus records of their work are never maintained. It is one of the main types of
unemployment in India.
5. Technological Unemployment: the situation when people lose their jobs due to
advancement in technologies. In 2016, the data of the World Bank predicted that the
proportion of jobs threatened by automation in India is 69% year-on-year.
6. Cyclical Unemployment: unemployment caused due to the business cycle, where the
number of unemployed heads rises during recessions and declines with the growth of
the economy. Cyclical unemployment figures in India are negligible. 
7. Frictional Unemployment: this is a situation when people are unemployed for a
short span of time while searching for a new job or switching between jobs. Frictional
Unemployment also called Search Unemployment, is the time lag between the jobs.
Frictional unemployment is considered as voluntary unemployment because the
reason for unemployment is not a shortage of jobs, but in fact, the workers themselves
quit their jobs in search of better opportunities

Causes of Unemployment
The major causes of unemployment in India are as mentioned below:

 Large population.
 Lack of vocational skills or low educational levels of the working population.
 Labour-intensive sectors suffering from the slowdown in private investment
particularly after demonetisation
 The low productivity in the agriculture sector plus the lack of alternative opportunities
for agricultural workers that makes transition among the three sectors difficult.
  Legal complexities, Inadequate state support, low infrastructural, financial and market
linkages to small businesses making such enterprises unviable with cost and
compliance overruns.
 Inadequate growth of infrastructure and low investments in the manufacturing sector,
hence restricting the employment potential of the secondary sector.
 The huge workforce of the country is associated with the informal sector because of a
lack of required education or skills, and this data is not captured in employment
statistics.
 The main cause of structural unemployment is the education provided in schools and
colleges are not as per the current requirements of the industries. 
 Regressive social norms that deter women from taking/continuing employment.

Impact of Unemployment
The unemployment in any nation have the following effects on the economy:

 The problem of unemployment gives rise to the problem of poverty.

 The government suffers extra borrowing burden because unemployment causes a
decrease in the production and less consumption of goods and services by the people.
 Unemployed persons can easily be enticed by antisocial elements. This makes them
lose faith in the democratic values of the country.
 People unemployed for a long time may indulge in illegal and wrong activities for
earning money which increases crime in the country.
 Unemployment affects the economy of the country as the workforce that could have
been gainfully employed to generate resources actually gets dependent on the
remaining working population, thus escalating socio-economic costs for the state. For
instance, a 1 % increase in unemployment reduces the GDP by 2 %.
 It is often seen that unemployed people end up getting addicted to drugs and alcohol
or attempts suicide, leading to losses to the human resources of the country.

Unemployment in India

 Unemployment Rate in India decreased to 4.90 percent in 2013 from 5.20 percent
in 2012.
 Unemployment Rate in India averaged 7.32 percent from 1983 until 2013,
reaching an all-time high of 9.40 percent in 2009 and a record low of 4.90 percent
in 2013.
 Unemployment Rate in India is reported by the Ministry of Labour and
Employment, India.
 According to “Annual Employment and Unemployment Survey Report 2013-14”
the rates of unemployment on Usual Principal State (UPS) in the country as
follows.
o Aggregate Unemployment Rate – 4.7%
o Unemployment Rate in rural areas- 4.9 %
o Unemployment Rate in urban areas- 5.5 %
o State having maximum unemployment people Sikkim
 o State having the least unemployed people – Chhattisgarh
o State having maximum unemployment rate – Kerala

INFLATION
Inflation is a sustained increase in prices, as measured by some broad index (consumer price
index) over months or years, and reflected in the correspondingly decreasing purchasing
power of the currency.
There are three major types of inflation.

 Cost-push inflation is due to wage increases that cause businesses to raise prices to
cover higher labor costs, which leads to demand for still higher wages.
 Demand-pull inflation results from increasing consumer demand financed by easier
availability of credit.
 Monetary inflation is caused by the expansion in money supply.
 Deflation is downturn in an economic cycle caused by circumstances, or brought
about by government policies. Inflation may or may not result in higher levels of
output and employment, significant deflation always results in lower output and
employment.
 Hyperinflation is caused due to ruinously high increase (50 percent or more per
month) in prices due to the near total collapse of a country’s monetary system
rendering its currency almost worthless as a medium of exchange.

Measurement of Inflation

1. Wholesale Price Index (WPI) – It is estimated by the Ministry of Commerce &

Industry and measured on a monthly basis.
2. Consumer Price Index (CPI) – It is calculated by taking price changes for each item in
the predetermined lot of goods and averaging them.
3. Producer Price Index – It is a measure of the average change in the selling prices over
time received by domestic producers for their output.
4. Commodity Price Indices – It is a fixed-weight index or (weighted) average of
selected commodity prices, which may be based on spot or futures price
5. Core Price Index – It measures the prices paid by consumers for goods and services
without the volatility caused by movements in food and energy prices. It is a way to
measure the underlying inflation trends.
6. GDP deflator – It is a measure of general price inflation.

Effect of Inflation on the Economy

The effect of inflation on the economy can be stated as:

  The effect of inflation is not distributed evenly in the economy. There are chances of
hidden costs for different goods and services in the economy.
  Sudden or unpredictable inflation rates are harmful to an overall economy. They lead
to market instability and thereby make it difficult for companies to plan a budget for
the long-term.
 Inflation can act as a drag on productivity as companies are forced to mobilize
resources away from products and services to handle the situations of profit and losses
from inflation.
 Moderate inflation enables labour markets to reach equilibrium at a faster pace.

PHILIPS CURVE

Short-Run Phillips Curve: The short-run Phillips curve shows that in the short-term there is
a trade-off between inflation and unemployment. Contrast it with the long-run Phillips curve
(in red), which shows that over the long term, unemployment rate stays more or less steady
regardless of inflation rate.

Historical application

During the 1960’s, the Phillips curve rose to prominence because it seemed to accurately
depict real-world macroeconomics. However, the stagflation of the 1970’s shattered any
illusions that the Phillips curve was a stable and predictable policy tool. Nowadays, modern
economists reject the idea of a stable Phillips curve, but they agree that there is a trade-off
between inflation and unemployment in the short-run. Given a stationary aggregate supply
curve, increases in aggregate demand create increases in real output. As output increases,
unemployment decreases. With more people employed in the workforce, spending within the
economy increases, and demand-pull inflation occurs, raising price levels.

Therefore, the short-run Phillips curve illustrates a real, inverse correlation between
inflation and unemployment, but this relationship can only exist in the short run. The
idea of a stable trade-off between inflation and unemployment in the long run has been
disproved by economic history.
FINDINGS & ANALYSIS
INFLATION IN INDIA
Table 3.1 and Figure 3.1 below feature an overview of the inflation in India for a period of 10
years (2004 to 2014).

Year WPI (AC) CPI (WI)

2004-05 6.48 4.00

2005-06 4.50 4.23

2006-07 6.60 6.70

2007-08 4.67 6.40

2008-09 8.06 9.02

2009-10 3.81 12.41

2010-11 9.56 10.43

2011-12 8.93 8.33

2012-13 7.37 10.26

2013-14 5.97 9.77

Table 3.1.1: WPI and CPI in India

 Chart Title
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14
WPI (AC) CPI (WI)

Figure 3.1.1: WPI and CPI in India over a period of 10 years

India used Wholesale Price Index (WPI) as the measure for inflation but new Consumer Price
Index (CPI) is declared as a new standard to measure inflation.
For Wholesale Price Index, 2004-2005 has been taken as the base year. WPI included 3
categories of items:

• Primary Articles
• Fuel, Power, Light and Lubricants
• Manufactured Products

This practice has been discontinued since 2012, when CPI system was reformed.

Difference between the old and the reformed CPI

Before 2011 After 2011

There were 4 subtypes of CPI: Three types of CPI:
• Agricultural Labourer (AL)  Entire urban population
• Rural Labourer (RL)  Entire rural population
• Industrial Workers (IW)  Urban + Rural
• Urban Non-Manual Employees
(UNME)
Subtype 1,2 and 3 were prepared by All prepared by Ministry of Statistics and
Ministry of Labour and Employment Programme Implementation
Subtype 4 was prepared by Ministry of
 Statistics and Programme Implementation
Base years for different Subtypes were Same base year (2010) for all types
different:
AL: 1986
RL: 1986
IW: 2001
UNME: 1984

India has seen both high and low inflation, and plotting the graph since 1953 puts things in
perspective.

Figure 3.1.2 India Inflation (1953 to 2011)

Fuelled by rising wages, property prices and food prices inflation in India today is an
increasing problem. Inflation is currently around 8%. This inflation has been a problem
despite periods of economic slowdown. For example, in late 2013, Indian inflation reached
11%, despite growth falling to 4.8%. This suggests that inflation is not just due to excess
demand, but is also related to cost push inflationary factors. For example, supply constraints
in agriculture have caused rising food prices. This causes inflation and is also a major factor
reducing living standards of the poor who are sensitive to food prices. The Central Bank of
India have made efforts for reducing inflation a top priority and have been willing to raise
interest rates in order to curb inflation, but cost push inflation is more difficult to solve and it
may cause a fall in growth as they try to reduce inflation.

UNEMPLOYMENT RATE IN INDIA

In India, National Sample Survey Organization (NSSO) calculates the unemployment rates
every 5 years, so the unemployment numbers during the 5 years’ gap is not known accurately.
Labour Bureau of the Government of India started conducting surveys on employment-
unemployment in 2009-2010 and based on that they came up with an unemployment rate.
As per Labour Bureau of the Government of India, the unemployment rate in 2009-2010 was
9.4%, and it was split out as 10.1% in rural areas and 7.3% in urban areas. The
unemployment rate is calculated as a percentage of labor force and not the total population.

Table 3.2 gives the Estimated Unemployment Rate from year 2004-05 to 2013-14.

Year Unemployment Rate (%)

2004-05 9.2

2005-06 8.9

2006-07 7.8

2007-08 7.2

2008-09 6.8

2009-10 9.4

2010-11 9.4

2011-12 9.8
 2012-13 8.5

2013-14 8.8
Table 3.2.1: Unemployment Rate in India

Unemployment Rate
12
10
8
6
4
2
0
2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14
Unemployment Rate

Figure 3.2.1: Unemployment Rate in India

India continues to have the problem of unemployment and underemployment despite

continuous policy emphasis and programmes to eliminate the problem. Current
Unemployment rate in India is 8.8%. The unemployment rate in India is measured in three
ways based on National Sample Survey (NSS) data: based on usual status (US), current
weekly status (CWS) and current daily status (CDS). From 1983 till 2011, Unemployment
rates in India averaged 900 percent reaching an all-time high of 9.4 percent in December
2010 and a record low of 3.8 Percent in December 2011. In India, the unemployment rate
measures the number of people actively looking for a job as a percentage of the labour force.

The National Sample Survey Office (NSSO) released the findings of the Employment and
Unemployment Survey 2011-12 in June, 2013. The EUS 2009-10 had shown that
employment growth by various indicators was far below expectations. The findings of the
survey reveal that over nine million persons found employment between 2009-10 and 2011-
12. It must also be noticed that the average growth in employment between 2004-05 and
2011-12 remains low at 2.5 million per year. Also, a growing proportion of the workforce is
moving to non-farm activities, and a falling proportion is engaged on a casual wage.

The Government of India has taken several steps to decrease the unemployment rates like
launching the Mahatma Gandhi National Rural Employment Guarantee Scheme which
guarantees a 100 day employment to an unemployed person in a year. It has implemented it
in 200 of the districts and further will be expanded to 600 districts. In exchange for working
under this scheme the person is paid 150 per day.

PHILIPS CURVE IN INDIA

The inverse relationship in the above chart proves the negative relationship between inflation
and unemployment rate.

Why the Indian government is unable to reduce unemployment in India in the long run
using inflation?

According to the Phillips Curve increasing wage rates will not help to reduce the
unemployment level indefinitely. As increase in wage rates initially reduces unemployment
by inducing more people to work. However, it also leads to overall increase in prices as
employers have to compensate for higher wage rates by charging higher prices. This reduces
the real wage of workers and unemployment rate again Increases to the previous level. At the
same time prices have increased. The overall effect is that unemployment fluctuates around
its natural rate which is high in India and prices continue to rise

In the graph below we have shown the trends for inflation and unemployment from 2004-05
to 2013-14.
We can see that the inflation line is upward sloping, this is mainly due to rising food, fuel
prices etc. But the unemployment trend instead to falling (as inflation increases) is a
horizontal line showing that the unemployment rate remains constant in the long run.

For a country like India where inflation is a very relevant issues it is not possible to increase
employment at the cost of rising prices.