Question

Write an essay about ''Inflation&unemployment''

Answer 1

If the economy overheats; if the pace of economic growth is higher than the rate of long-term trend – then we will start to get inflation that pulls demand. Companies are pushing up prices, as demand grows faster than supply. Such higher growth can lead to lower unemployment in the short term, as firms take on more workers. This rate of economic growth, however, is unsustainable – e.g. consumers may get into debt to increase expenditure, but as the economy falters, they cut spending that leads to lower AD. Also, Monetary authorities will tend to increase interest rates to reduce inflation if inflation increases. A sharp rise in interest rates can bring down economic growth, leading to recession and unemployment

If an economy has a very low 'core inflation' underlying rate, e.g. 1 per cent, then this is a sign that the economy is growing too slowly. This level of inflation means surplus capacity is available and there is a deficit in production. Hence unemployment is likely to be higher with slow growth. In this scenario, implementing an expansionary monetary policy that requires a higher rate of inflation could help fuel economic growth and result in lower unemployment.

As inflation accelerates, because of higher wages, workers can provide labor in the short term – leading to a fall in the unemployment rate. However, in the long run, as employers are well conscious of the erosion of their spending power in an inflationary setting, their ability to supply labor is diminishing, and the rate of unemployment is rising as normal. Wage inflation and overall price inflation however continue to rise

Hence, higher inflation will not help the economy by a reduced unemployment rate in the long term. On the same time, a lower rate of inflation or a higher rate of unemployment does not place a loss on economy. Since inflation has no long-term effect on the unemployment rate, the long-run Phillips curve morphs into a vertical line at the natural unemployment rate.