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Like other branches of Economics, Macro economics too has been witnessed revisions and additions. They are: Phenomenon of Phillips Curve Stagflation Natural Rate of Un-employment Rational Expectations Definition of inflation: There are many definitions of inflation. By inflation most people understand a sustained and substantial rise in prices. For example: •Crowther defines inflation as a state in which the value of money is falling.
•Harry G Johnson, “We define inflation as substantial increase in prices”.
•Milton Friedman writes ”By inflation I shall mean a steady and sustained rise in prices” •According to Rowan, “inflation is the process of price increase” •Prof Samuelson puts it as “Inflation occurs when the general level of prices and costs is rising”. •Thorp and Quandt, opine that it is of great help to define inflation in terms of observable.
•To some economists, Inflation is a pure monetary phenomenon, while to others, it is a post-full employment phenomenon.
•Phenomenon and for his reason the process of rising prices should be considered as inflation.
Types of Inflation: Open Inflation: When Government interference is nil and, prices rise freely, it is situation of open inflation. Suppressed Inflation: when increase in price prevented by government through certain measures like price control or rationing is suppression inflation. Depend on Degree of Price rise, inflation can be categorized as: Creeping Inflation is the mildest form and price rise imperceptibly over period of time. Walking Inflation gets helps from some other factors and price rise becomes more marked, is known as walking inflation. Running inflation is that the price rise becomes more rapid and the price rise by fits and starts. Hyper Inflation where the prices rise every moment in fact limitlessly.
Modern views on Inflation: Demand Pull Inflation: It is due to excess demand which is pulled above what economy is capable of producing in the short period.
For instance, Demand for goods > Supply of Goods leads to increase in prices and increase in costs, increase in incomes than increase in demand so that price rise.
Cost-Push Inflation: It is due to increase in cost of production. We call it as wage spiral inflation also which means rise in prices is due to increase in wages since it is one of the important cost component.
Post Keynesian view on Inflation:
Inflationary pressures in terms of conflicts among different classes.
Classes are: Workers, Capitalists, Government. Each one these classes attempts to squeeze as much of the surplus as in the economy is possible by way of wages, profit and Taxes etc these leads to inflation. ,<<<<<The End>>>>>>>
Phillips Curve Analysis:
One of the objectives of this study was to identify whether the demand pull or cost push had been strong in the British economy Another objective is to determine the extent by which restrictive monetary policy and fiscal policy would be appropriate for the control of inflation. A W Phillips in 1958 drew a diagram plotting the rate of inflation against the rate of unemployment in the United Kingdom for each year from 1861-1957.
He found clear evidence of a negative relation between inflation and unemployment. When unemployment is low, inflation was high, and when unemployment was high, inflation was low, often even negative.
Phillips found that wage rates rose rapidly when un-employment was low and remain unchanged where about 5.5% of the labor force was out of job. Phillips determined that a rate of 5.5% un-employment in the UK is needed, if wages are to be held steady. And a rate of 2.5% un-employment is needed if prices are to be steady.
Phillips stated that there will be an inverse relationship between rate of UE and rate of Wages over a period of time. It means that PC slopes downwards from left to right.
Samuelson & Solow Phillips Curve:
Two years later, Paul Samuelson and Robert Solow replicated Phillips’ exercise for the United States, using data from 1900-1960.
Using CPI inflation as a measure of the inflation rate. Apart from the period of very high unemployment during the 1930 to 1939, there also appeared to be a negative relation between inflation and unemployment in the United States.
This relation, which Samuelson and Solow labeled the Phillips curve, rapidly become central to macroeconomic thinking and policy. It appeared to imply that countries could choose between different combinations of unemployment and inflation. A country could achieve low unemployment if it was willing to tolerate higher inflation or it could achieve price level stability if it was willing to tolerate higher unemployment.
In the 1970s, however, the relation broke down. There was both high inflation and high unemployment, clearly contradicting the original Phillips curve. This situation is nothing but stagflation.
Criticism: J A Penchman has pointed out that the inverse relationship in Britain economy is rather exaggerated. Studies similar to Phillips were conducted by Lipsey & Routh covering the period 1862-1957 and raised objections to the validity of Phillips data and method of aggregation. R J Bhatia, covered the period 1900-1958 found that there was much less evidence of Philips type relationship. The End------------
Natural Rate of Un-Employment (NRU): In the late 1960s, two economists, Milton Friedman and Edmund Phelps, questioned the existence of a trade-off between unemployment and inflation. They questioned it on logical grounds, arguing that such a trade-off could exist only if wage setters systematically under predicted inflation, and that they were unlikely to make the same mistake forever. Friedman and Phelps also argued that if the government attempted to sustain lower unemployment by accepting higher inflation, the trade-off would ultimately disappear, the unemployment rate could not be sustained below certain level, a level they called the ‘Natural Rate of Un-Employment’. Events proved them right, and the trade-off between the unemployment rate the inflation rate indeed disappeared. Today, most economists accept the notion of a natural rate of unemployment. NRU as the rate of Un-employment which has the property that is consistent with equilibrium in the structure of real wage rate, corresponding to an equilibrium level of output in any economy, there is an accompanying of Un-employment determined by real forces, this rate can be consider as Natural Rate. This rate also called as ‘Nonaccelerating inflation rate of Un-employment’.
NRU Hypothesis is also known as ‘Accelerationist Hypotheses or Adoptive Expectations Hypotheses’.
Tobin’s Modified Phillips Curves: This has been introduced by Tobin in 1972. He presented his curve in the following: The lower portion of the curve slopes downward to the right, while the upper portion of the curve is a vertical one. The lower portion of the curve suggests possibility of a trade-off between unemployment and inflation at relatively high levels of unemployment. The upper portion of the curve suggests no trade-off between inflation and unemployment at low levels of unemployment. Tobin’s model suggests that a Phillips trade-offs exists within certain limits. But it becomes increasingly difficult to maintain the trade-off at low levels of unemployment (Uo).
Tobin’s analysis suggests that at high levels of unemployment, an expansionary monetary and fiscal policy will be successful in reducing the level of involuntary unemployment. As unemployment falls, the trade-off disappears. The expansionary monetary and fiscal policy fails to reduce the level of unemployment. Further, use of the expansionary monetary and fiscal policy results only in inflation.
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