Inflation – Unemployment Relationship | Economics Help
curve in its traditional inflation/unemployment format. Furthermore, during the s inflation . In the mids the correlation between. List of Figures. Figure 1. Inflation and Unemployment in the s. relationship between the rate of increase in wages and the rate of unemployment . Comparing rates of . National Bureau of Economic Research, , pp. (ii) There exist a significant causal relationship among the . From the graph of unemployment and inflation above inflation was and unemployment was.
Section 1 introduces the research project by discussing the objective, hypothesis and significance of the study. The scope and limitation of the study are also mentioned in introduction. Literature review reviews the literature, whereas methodology outlines and discusses the methodology used in the study. Result and discussion presents and analyses the empirical results.
Conclusion concludes the study, with some policy recommendations on how to stabilize the economy of the Gambia and insulate it from the twin adverse effects of high unemployment and high inflation. Objective of the study The primary objective of this study is to examine if there is any trade-off between inflation and unemployment in the Gambia.
The research hypothesis The paper will be guided by the following hypothesis: Inflation and unemployment are current issues that are affecting the Gambian economy. However, were the two variables neglected by the successive governments or have the twin problems defied all economic theories? A study on the relationship between inflation and unemployment in the Gambian context will help economic decision-makers in the country greatly by helping them to acquire the knowledge and skills needed to face the issue of inflation and unemployment in the Gambia.
Trade off between unemployment and inflation
Scope and limitation of the study The research work intends to study the inflation and unemployment situation in the Gambian economy between the periodusing the new Keynesian model version of the Philips Curve. Apart from the two main variables of interest, which is the inflation and unemployment, other variables that affect inflation such as the money supply, and the interest rates were also included.
- The Relation between Inflation and Unemployment in the Gambia: Analysis of the Philips Curve
Due to lack of data on unemployment, output gap which is the difference between actual output and expected output was used as a proxy variable for unemployment. Literature Review Stability of domestic prices and full employment are undoubtedly parts of the macroeconomic goals which governments strive to achieve. Macroeconomic performance is judged by three broad measuresunemployment rate, inflation rate, and the growth rate of output.
It generates welfare loss in terms of lower output thereby leading to lower income and wellbeing. Mankiw [ 4 ] defines rate of inflation as the percentage change in the overall level of prices. Nevertheless, there are other factors which cause inflation including the interest rate and exchange rate.
He contended that the greater the aggregate expenditure, the larger the inflationary gap and the more rapid the inflation. As for unemployment, the Keynesian economists hold that an increase in unemployment reduces income, which reduces consumption, and reduces aggregate output.
On the other hand, inflation was explained by the monetarist in terms of excessive growth of the money supply relative to real output. Based on the Permanent Income Hypothesis PIHa reduction in employment and current receipts only affects output to the extent that the anticipated income declines. Before the existence of what has become famously known as the Philips Curve in unemployment and inflation trade-off in economics, those two variables were treated as distinct subjects.
Prior to the emergence of Philips Curve, different policy solutions were offered by different schools of thoughts and there were however, no major attempts made to examine inflation and unemployment simultaneously. Following the introduction of the Philips curve by A. Philips init was only then inflation and unemployment were examined simultaneously by traditional economists, thus, establishing a trade-off between inflation and unemployment.
However, economists such as Milton Friedman and Edmund Phelps disapproved Phillips curve thesis, stating that the trade-off between unemployment and inflation only existed in the short-run and that in the long-run, the Phillips curve is vertical. This led to the introduction of the Natural Rate Hypothesis. Also, empirical analyses carried out by other economists over the years, have in one way or the other disproved the authenticity of the trade-off thesis as postulated by Phillips. Both high inflation rates and high unemployment rates were discovered to co-exist, giving rise to what has come to be known as stagflation.
According to the interpretation of the Philips curve by the monetarist mostly Friedman and Phelpshypothesis of adaptive expectation was used in which they explained that subjects adjust their expectations considering the activities of previous period.
However, proponents of this concept believed that the entities do not have fully reliable information, therefore, will respond to changes with some delay [ 5 ]. Monetarist believed that every single action that is a stimulating policy can lead to growth in wages and national income, but then subjects need to adapt to the new conditions, and they will start to revise the terms of sale factors.
This will lead to an increase in the level of aggregate supply. As a result we will get the initial value of employment, but with the higher inflation. There still remains an underlying relationship between unemployment and inflation. What can happen in a period of cost-push inflation is that we get a worse trade-off.Measuring Inflation
Empirical evidence of the Relationship between Unemployment and Inflation In the early s, the US experienced a high inflation partly result of oil prices rising. But, then there was a recession — falling output. Then economic growth in the s caused a fall in unemployment.
Inflation stayed low until the late s, when the economy started to get close to full capacity and inflation started to creep up again. This caused a rise in unemployment.
Inflation – Unemployment Relationship
Inflation increased in because of cost-push factors. Monetarist Phillips Curve Diagram Rational expectation monetarists believe there is no trade-off even in the short-term. They believe if the government or Central Bank increased the money supply, people would automatically expect inflation, so there would be no improvement in real GDP. Falling Inflation and Falling Unemployment In some periods, we have seen both falling unemployment and falling inflation.
For example, in the s, unemployment fell, but inflation stayed low. This suggests that it is possible to reduce unemployment without causing inflation. However, you could argue there is still a potential trade-off except the Phillips curve has shifted to the left, because there is now a better trade-off.
The Relation between Inflation and Unemployment in the Gambia: Analysis of the Philips Curve
It also depends on the role of Monetary policy. Rising Inflation and Rising Unemployment It is also possible to have a rise in both inflation and unemployment. If there was a rise in cost-push inflationthe aggregate supply curve would shift to the left; there would be a fall in economic activity and higher prices. For example, during an oil price shock, it is possible to have a rise in inflation cost-push and rise in unemployment due to lower growth. However, there is still a trade-off.