RELATIONSHIP BETWEEN UNEMPLOYMENT RATE AND INFLATION RATE

Relationship between the unemployment rate and the inflation rate

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Abstract

Inflation rate and unemployment rate are the essential components of the economy and are

integral. Professional contrasting controversies between unemployment and inflation has been an

intertwined concept between the role that fiscal, monetary and other elements that affect the

aggregate market demand. One aspect deals with how a shift in aggregate nominal product or

service demand, functions on its own through shifts in price levels and unemployment rates with

the other one accounting for the direct shifts in a change in aggregate nominal markets. If these

two elements feature in an economy, they come along with numerous negative consequences of

the people in that economy given social and economic. The paper explores the relationship

between two elements of an economy; the inflation and unemployment through the establishment

of the negative and positive linear relationships between the two in the Phillips curves. Through

the Phillips curve hypotheses, the outcomes indicated that the statistical elements and other

related variables verify a strong association between the rates of unemployment and inflation in

the US.

Relationship between the Unemployment Rate and Inflation Rate

The concepts Philips Curves gave were negative between unemployment rates and

inflation rates, the main ideal objective, and core debate on policy. Philips illustrated that the

Philip Curve might be utilized to represent the rates of inflation, and to a greater extent, the

unemployment rates tradeoff. The concepts of Philip Curves are essential to economists because

it determines policy and regulatory discussions governing money and other forms of transactions

in an economy (Fitzgerald et al., 2020). The principles underpinning the relationship have been

inflation rates. The unemployment rates emphasize the need for global policy developers to
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conduct their mandates cautiously in policy management because the two elements of the

economy may be the push in different directions. The relationship between unemployment rates

and inflation rates has been confirmed by economists across the globe using advanced

econometrics models such as Vector Autoregressive, the new Philips Curved models, and error

correlation approaches.

The Phillips curve illustrates an inverse relationship between interest elements, rates of

inflation, and unemployment. From the curves, inflation rates increase as unemployment

decreases. Philips curves hypothesize that the elements are inversely related. The inverse relation

is, however, nonlinear. Short-term curves follow an L-shape trend when unemployment rates are
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places at the x and inflation at the y-axis.

Fig 1 Illustrates the theoretical Philips curve showing the inverse trends between the rates

of unemployment and inflation.

From the curve, it is noted that as one element rise, the other automatically fall. Philips

curve theory is predictable. Statistical information from the models of 1960 on the tradeoffs

between unemployment and inflation rates is in tandem with the conclusions of other research
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scholars. Philips curves provided potential economic policy results; monetary and fiscal policy

can be utilized as a powerful tool in achieving full-scale employment at a price of relatively

higher levels or minimal inflation at the cost of relatively lowered employment.

On a different note, however, when policymakers and other government institutions tried

to use the Philips curves to regulate inflation and unemployment rates, the relationships came far

from the theoretical expectations. Statistical data dating back to the 1970s onwards failed to

adhere to the curve's theoretical predictions (Donayre & Panovska., 2018). For decades, inflation

and unemployment rates have always been relatively higher than Philips' prediction; a

phenomenon referred to in theory as "stagflation." At this point, Philip's curves on rates of

unemployment and inflation were scientifically proven to be unstable in a few dimensions.

Hence they may not develop policies and other economic measures.

Philips Curves; Inflation rate vs unemployment rate (2000-2013)

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Fig 2 Source; Bureau of Labor Statistics, US

In the US, Philips curves between 2000-2013 above, the information points in the graph range

from Jan 2000 to April 2013. It is notable that they do not conform to expectations; they also do

not form the L shape as predicted by the short-run Philips Curve (Aydin & Esen., 2017). Even

though it was indicated in the 1860s and late until the 1960s to be stable, it was shown that

Philips's curves were unstable and hence invalid and not used for policy and economic

development after the 1970s.

The Phillips Curve Related to Aggregate Demand

The Phillips curves below illustrate the inverse association between rates inflation and

unemployment. High unemployment implies low inflation and vice versa. The aggregate demand
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and Philips curve bear similar elements. The Philips curve indicates the association between

unemployment and inflation rates which directly impacts the aspects of price levels of aggregate

demand components.

To comprehend the relationships, the curves below are considered on the assumption that

the aggregate supply marked as AS is stagnant and that the component of aggregate demand

begins with curve AD1. There exist an original point of equilibrium and the actual output of

GDP at point A. They imagine that there is a rise in the component of aggregate demand, which

then causes a right shift of the curve AD2 through point AD4. With an increase in aggregate

demand, the unemployment rates fall, and more labourers are taken up for jobs, prices, and levels

of GDP outputs increase. The scenario demonstrates an aspect of the demand-pull form of

inflation.
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Fig 3 Phillips Curve and Aggregate Demand curves above indicate that a significant rise from

points AD1 to AD2 leads to an increase in the real GDP. In essence, this also implies that there

are corresponding shifts along the Philips curves with an increase and decrease in inflation and

unemployment, respectively.

The Long-term Phillips Curve

The Phillips long term curve in economic theory is shown by use of a line that is vertical

at the rate of natural unemployment. In the long run, unemployment and inflation rates do not

relate to all possible economic dimensions. Phillips curve indicates the relationship between

unemployment and inflation but does not show how the curve is accurate for long-term

relationships (Albuquerque & Baumann., 2017). Research studies indicate that there must not

relationships between the components of unemployment and inflation rates in an economy in the

long run. A fall in the rates of unemployment may sometimes lead to a rise in inflation, but on a

short term basis only. In the long run, rates of unemployment and inflation have no relationships.

Graphically put, this implies that the Philips Curve, in theory, would most likely imply that it is

vertical at the point of natural unemployment rate or, hypothetically, the rate of unemployment

on condition that the aggregate production is at the level of the long run.

Natural Rate Hypothesis

The natural rate hypothesis relating to the rates of unemployment is also referred to as the

stagnant theory of inflation level of unemployment shortened, or Edmund Phelps and Milton

Friedman advanced the idea. According to the theory, economic policies founded on

expansionary elements only lead to short-term unemployment rates because the economy will
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automatically adjust to the natural speed (Quévat & Vignolles., 2018). Inflation falls when the

rate of unemployment is equivalent to the birth rate.

For instance, NAIRU and Phillips Curve show that even though the economy begins with

an initial comparative low rate of inflation point A, a fall in unemployment level is lethal and

leads to a rise in inflation to point C. In theory, the unemployment rates cannot lie below the

natural unemployment rates, or NAIRU, with little or no increase in the quality of inflation in the

long term.

Fig 4 For NAIRU and Phillips Curves

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The main reason to account for the short-term shift in the Philips curve is the shift in the

expected inflation. Elite workers will recognize their wages have not been fair with them given

inflation rates and that their earnings have been relatively reduced. As such, they will most

likely negotiate for a higher pay having in mind the anticipated inflation rates.

The Short-term Phillips Curve

On the other hand, the short-run Phillips curve indicates an inverse relationship between

the rates of unemployment and inflation. While the long-run Philips Curve is a line at the y-axis

to indicate independence between employment and inflation rates, the Philips short-run curve is
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approximately L shaped to imply in the initial inverse relationship that existed between the two

components.

Fig 5. Short term Philips curve

The curve above is a short-term Philips curve, which illustrates that there is a significant tradeoff

between the two components, rates of unemployment and inflation in the short term. As opposed
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to the long-term Philips curve shown in red in the curve above, the rates of unemployment do not

show certain stability irrespective of inflation rates.

References

Albuquerque, B., & Baumann, U. (2017). Will US inflation awake from the dead? The role of

slack and nonlinearities in the Phillips curve. Journal of Policy Modeling, 39(2), 247-271.

Aydin, C., & Esen, Ö. (2017). Inflationary Threshold Effects on the Relationship between

Unemployment and Economic Growth: Evidence from Turkey. International Journal of

Economic Perspectives, 11(2), 88-97.

Donayre, L., & Panovska, I. (2018). US wage growth and nonlinearities: The roles of inflation

and unemployment. Economic Modelling, 68, 273-292.

Fitzgerald, T. J., Jones, C., Kulish, M., & Nicolini, J. P. (2020). Is There a Stable Relationship

between Unemployment and Future Inflation? (No. 614). Federal Reserve Bank of

Minneapolis.
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Quévat, B., & Vignolles, B. (2018). The relationships between inflation, wages, and

unemployment have not disappeared. A Comparative Study of the French and American

Economies. Conjoncture in France March.