The Long- Run Phillips Curve (LRPC)
The Long- Run Philips Curve, LRPC shows the relationship between inflation and unemployment when the actual inflation rate equals the expected inflation rate. If unemployment falls below its natural rate, inflation will accelerate and vise- versa.
The LRPC is a vertical line at the Natural Unemployment Rate (Frictional Unemployment plus Structural Unemployment).
Along the LRPC, an increase in the inflation rate will have no effect on the unemployment rate.
The Short-Run Phillips Curve (SRPC)
SRPC indicates the negative relationship of trade-off between inflation and unemployment.
The LRPC curve is a vertical line at the natural rate of unemployment, but the SRPC curve is roughly L-shaped.
Only in the short-run, the inverse relationship shown by the SRPC exists; there is no trade-off between inflation and unemployment in the long run.
To show the relationship between inflation and unemployment we will have to refer to The Philip Curve by A.W.Phillips as shown in Figure 1.
Figure 4: The Philip Curve
Source from: http://www.bized.co.uk
Figure 4 shows the curve sloped downward from left to right and that inflation and unemployment are inversely related. The negative relationship between inflation rate and unemployment rate can be explained by the aggregate demand, AD and aggregate supply, AS model. An unexpectedly large increase in AD raises the inflation rate and increase real GDP, which lowers the unemployment rate. Hence, higher inflation is associated with lower unemployment shown by a movement along a short run PC. Thus, when there is high inflation, there is low unemployment and when there is low inflation, there is high unemployment. For example, based on Table 1 and Table 2 in ...
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... no change in the unemployment in the long- run.
1970's Phenomenon- Stagflation
As we have mentioned earlier that inflation and unemployment are inversely related. When inflation decrease, unemployment increase and when inflation increase, unemployment decrease. However during the year 1970's, both inflation and unemployment increased at the same time which is totally against the classic Phillips Curve Theory. This phenomenon is known as stagflation. Based on NAIRU theory this phenomenon can be explained. According to the theory of NAIRU, the simultaneously high rates of unemployment and inflation could be explained because workers changed their inflation expectations, shifting the SRPC and increasing the prevailing rate of inflation in the economy. At same time, unemployment rates were not affected, leading to high inflation and high unemployment in the 1970's.
First, I will discuss the time period between 1973-1974. Because the unemployment and inflation rates are higher than normal, we can assume that the aggregate-demand curve is downward-sloping. When the aggregate-demand curve is downward-sloping, we know that the economy’s demand has slowed down. When the economy’s demand has slowed down, businesses have to choice but to raise prices and lay off workers in order to preserve profits. When employers throughout the country respond to their decrease in demand the same way, unemployment increases.
The trends in unemployment affect three important macroeconomics variables: 1) gross domestic product (GDP), 2) unemployment rate, and 3) the inflation rate.
The adaptive expectations theory assumes people form their expectations on future inflation on the basis of previous and present inflation rates and only gradually change their expectations as experience unfolds. In this theory, there is a short-run tradeoff between inflation and unemployment which does not exist in the long-run. Any attempt to reduce the unemployment rate blow the natural rate sets in motion forces which destabilize the Phillips Curve and shift it rightward.
Yes, it will increase inflation but create more job opportunities and unemployment will decrease if government intervention occurs. Yes in the long run this might be bad but people care about tomorrow more than they care about 3 or 4 years from now or even more. As Lord Keynes once said “in the long run we are all dead”.
Prior to the 2007-2009 recession, the 1981-82 recession was the worst economic downturn in the United States since the Great Depression. Rising inflation of the U.S. dollar of the 1970s resulted in the tightened monetary policy from the Federal Reserve, while regime change in Iran led to rising oil prices. By the early 1980s, the United States found itself with falling inflation from before, but still rising unemployment. Unemployment grew from 7.4 percent at the start of the recession to nearly 10 percent a year later. The unemployment rate reached nearly 11 percent late in 1982. This was the apex of the unemployment rate of the post-World War II era.
In chapter nine ‘Why is there an employment/inflation trade-off?’ the authors critique the natural rate theory. They agree with the fact that wage setting is influenced by expectations of inflation but disagree that inflationary expectation affects ‘wage and price setting one for one’
PHILLIPS, A. W. (1958). The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957. Economica, New Series, Vol. 25, No. 100, pp. 283-299, November. Available at http://www.jstor.org/stable/2550759.
This article by Andrew McCathie posted in EarthTimes and titled “European inflation climbs unemployment at 12-year high was posted on Friday July 30 2010. The article reports that food and energy costs have played a critical role in driving up inflation in the 16-member eurozone. The rates of unemployment remained stagnant to its highest level during this time.
by working for others, being unable to find a job is a serious problem. Because
The largest cause of unemployment can be attributed to recession. The term recession refers to the backward movement of the economy for a long period. People spend only when they have to. (Nagle 2009). With people spending less there would be less money in circulation therefore, enterprises would suffer financially and people would suffer too. This is so because recession reduces the fiscal bases of enterprises, forcing these enterprises to reduce their workforce through layoffs. These enterprises lay off their workers in order to cut the costs they incur in terms of wage and salary payments.
The Effects of Government Spending and Borrowing Government borrowing can be inflationary because the government borrows from banks, which increases the money supply. Banks assume that consumers will not take more than 10% of their savings out and on that basis are able to lend to the government. This increases the money supply because the government has borrowed from the bank but the consumer’s savings stay the same and therefore there is more money in circulation. According to monetarist beliefs an increase in the money supply will directly increase inflation. Inflation can lead to unemployment, as people demand less due to higher prices and therefore demand for labor maybe decreased.
The debate of the relationship between inflation and unemployment is mainly based on the famous “Phillips Curve”. This curve was first discovered by a New Zealand born economist called Allan William Phillips. In 1958, A. W. Phillips published an article “The relationship between unemployment and the rate of change of money wages in the United Kingdom, 1861-1957”, in which he showed a negative correlation between inflation and unemployment (Phillips 1958). As shown in figure 1, when unemployment rate is low, the inflation rate tends to be high, and when unemployment is high, the inflation rate tends to be low, even to be negative.
Inflation is defined as an increase in the expected price level and has been the signal for an improving economy, but it has also weakened an economy due to the unemployment it usually produces which usually hurts the Middle class the most. A healthy rate of inflation means an expanding economy due to higher tax revenues for the government and higher wages for businesses that are booming due to the high demand of their products. But if inflation surpasses of what is expected than employer will have to reduce wages to meet these new prices. When the Federal Reserve creates inflation most argue that this is robbing people of the money that they have saved because they have to use it due to the rise in prices. Printing
...ies like this one have already been implemented mainly to reduce the overall budget deficit, rather than to reduce inflation.
There are many factors that affect the economy, inflation is one of them. Basically inflation is risingin priceof general goods and services above a period.As we see value of money is not valuable for the next years due to inflation. Today every country has facing inflationary condition in their economy.GDP deflator is a basictool that tells the price level of final goods and services domestically produced in an economy.GDP is stand for gross domestic product final value of goods and services, Furthermore GDP deflator shows that how much a change in the base year's GDP relies upon changes in the price level. . Inflation in contrast, how speedy the average prices intensity is increases or changes above the period so the inflation rate define the annual percentage rate changes in the level of price is as measure by GDP deflator more over GDP deflator has a advantage on consumer price index because it isn’t only based on a fixed basket of goods and services. It’s a most effective inflation tool to identify the changes in consumer consumption and newly produced goods and service are reflected by this deflator. Consumer price index (CPI) is also measure the adjusting the economic data it can also be eliminate the effects of inflation, through dividing a nominal quantity by price index to state the real quantity in term.