Impact Of Unemployment And Inflation On Gross Domestic Product Of Australia

Background of the study

Today, global economy faces some major financial and economic problem. Among them one significant problem is unemployment. Several nations suffer the problem of unemployment leading to insufficient economic growth. Unemployment and economic growth are the two major macroeconomic indicators for economic development of a nation. Policymakers simultaneously monitor the status of employment and economic growth before designing suitable policy (Thanh, 2015). The theoretical proposition explaining the relationship between unemployment and economy growth is known as Okun’s law. This is one of one most prominent macroeconomic theories that is found to hold for most of the developing and developed factor.

 Another important macroeconomics factor is inflation. Rate of inflation in an economy captures the movement in average price level. A change in the price level affects the economy in various ways. The relation between economic growth and inflation has been discussed widely in literature. Any nation targets to achieve a high economic growth along with a stability in the price level (Sadiku, Ibraimi & Sadiku, 2015).  A moderate inflation rate is often considered to have a favorable impact of economic growth. Not all economists accepts the fact that inflation has an unfavorable effect on social welfare and distribution. A high level of inflation however has a detrimental effect of economic growth (Ayres, Belasen & Kutan, 2014). The impact of inflation on economic growth is widely contested and offers a wide scope of research in this field.

The research aims to find out the impact of unemployment and inflation on Gross Domestic Product of Australia. Gross Domestic Product is used for capturing economic growth of a nation. By observing simultaneous movement of GDP, unemployment and inflation the paper aims to establish the relationship between GDP, inflation and unemployment.

Okun’s law proposes a relationship between unemployment and output growth. According to this law 1% fall in unemployment is associated with a decline in output by 3%. Following this proposition, in order to avoid output loss from unemployment, the economy needs to expand continuously (Law & Singh, 2014). There are several past studies that conduced empirical research on the relationship between output and unemployment. Most studies validated the impact of unemployment on output. The Okun’s coefficient however varies across nations depending on other macroeconomics variables. A study had been conducted on four Arab countries for evaluating Okun’s relation. The four chosen nations were Algeria, Morocco, Egypt and Tunisia. In this study Okun’s coefficient turned out to be insignificant (Shahid, 2014). For these nations, growth in aggregate output does not translate to a significant gain in employment.

In another study, three versions of Okun’s law has been estimated. The first version is the difference, the second version is the gap and the third version is the dynamic version. In this study, the effects on unemployment rate were computed by taking current level of output, past level of output and past unemployment rate. The study found that slow-down in economic output dies not always coincide with a high unemployment rate (Gomez, 2015). This holds for both short run and long run. A separate study conducted on unemployment and economic growth established that the two indicators move in opposite direction. The influence however found to be lower as compared to that proposed by Okun. Study conducted based on data set from Greece at the regional level found a consistent estimate for Okun’s coefficient. Literature based on data set for industrial countries concluded that, for these countries Okun’s coefficient tend to be larger (Ball, Jalles & Loungani, 2015) In these countries unemployment tends to more sensitive as a contraction of aggregate output is associated with a large lay off for industrial workers (Singla, Ahuja & Sethi, 2017). Authors of the research added that the coefficient might vary overtime as the relation between unemployment and output is subject to changes in technology, laws, demographics, social customs and preferences. Study that estimated Okun’s coefficient using gap version found a negative association between unemployment and output (Soylu, Çakmak & Okur, 2018).

Research aim

Past studies had been conducted to find out what level of inflation is detrimental to economic growth. The model of aggregate supply and aggregate demand explains a positive association between output and inflation. Phillips curve explains the association between inflation and unemployment rate (Seth & Araf, 2018). It depicts that unemployment is inversely related with inflation rate. The theory however fails to explain a situation where both unemployment and inflation remains high, a situation termed as stagflation. The endogenous growth theory and neo-classical growth attempted to find out the effect of inflation on economic growth. The monetarist school f economists suggested that inflation results when growth of money supply exceeds that of the output growth (Akeju & Olanipekun, 2014). The effect of inflation on economic growth depends on several macroeconomics factors. Empirical studies were conducted for determining effect of inflation on economic growth subject to other macro variables. These are money supply, potential output of the economy, interest rate, wage rate, exchange rate, expectation and trade openness (Bhattacharya, 2014). Several empirical studies conducted on this field in the past two decades confirmed a non-linear and negative impact of high inflation on economic growth. A study conducted on non-linear relationship between inflation and output growth taking 170 countries for a period ranging from 1960 to 1992 (Eggoh & Khan, 2014). The study confirmed that rate of inflation above 10 to 12 percent is usually detrimental to economic growth. Study using panel data for 140 countries for the period 1960 – 1998 found that, in the developed nation the threshold limit of inflation is 1-3%.  For developing countries, the threshold limits were found to be 7 to 11 percent while for other nations the threshold range varies between 8 to 12 percent (Ozturk, Sozdemir & Ulger,2014). Rate of inflation exceeding the threshold limit has a negative impact on economic growth. These studies confirmed the relationship between inflation and unemployment is non-linear in nature. Another revised study conducted on 40 countries concluded that the threshold limit is 19 percent in absence of regime intercept. With regime intercepts, the threshold limit falls to 12% (Madurapperuma, 2016). In the presence of detrimental effect of inflation policy makers target to lower inflation rate using the tool of interest rate.

Hypothesis 1:

Null hypothesis (H₀₁): There is no significant relation between unemployment and GDP of Australia.

Alternative hypothesis (H₁₁): There exists a statistically significant relation between unemployment and GDP of Australia.

Hypothesis 2

Null hypothesis (H₀₂): There is no significant relation between inflation and GDP of Australia

Alternative hypothesis (H₁₂): There is no statistically significant relation between inflation and GDP of Australia

In order to estimate the relation between economic growth, inflation and unemployment relevant data collected on the chosen variable. Economic growth of the nation is measured using the Gross Domestic Product. To measure the status of employment, rate of unemployment is taken as a choice variable. Consumer Price Index measures the cost of living in two different period. In Australia, percentage change in Consumer Price Index is used to measure the inflation rate in the economy. The chosen variables for the study is GDP, unemployment rate and inflation rate. Time series data are used to analyze the trend movement of the chosen variable. A sample period of five years ranging from 2012 to 2017 has been selected for the analysis. For GDP, Gross Domestic Product measured in current year prices is collected for the selected period. GDP measured in current year prices is known as nominal GDP. For employment status, data on unemployment rate is collected. So far as inflation is concerned, data on percentage change in Consumer Price Index is collected. In Australia, the Australian Bureau of Statistics publishes the data on important statistics. Secondary data on the three chosen variables are collected from official website of Australian Bureau of Statistics.

Employment and GDP

  The collected data are analyzed using quantitative analysis method. A quantitative approach aims find relevant evidences in order to support or reject the proposed hypothesis. For GDP and inflation quarterly data are available. For unemployment, ABS publishes monthly data. The original series value of the variables are taken and all the data are represented in quarterly interval. Data are analyzed using excel software. Statistical measures such as descriptive statistics, correlation and regression are used to analyze the data and draw conclusion.

The descriptive statistics includes the measure of central tendency, dispersion, skewness and kurtosis. These measures help to understand the overall distribution of the chosen data set. The analysis of correlation is used to estimate the association among three chosen variables. Correlation analysis is a statistical tool that shows association between variables. Sing of the correlation efficient shows the direction of the relationship while the magnitude reflects the strength of the relationship. A positive sign of correlation means a direct or positive relation. A negative correlation coefficient indicates an inverse relation between the two variable. Value of correlation closer to 1 indicates a strong relation while value of correlation close to 0 represents a weak relation.

Correlation shows degree of association among the variables. However the cause and effect relationship between the two or more variables is determined from the regression analysis. After analyzing the correlation regression needs to be conducted to estimate direction of relationship. For the proposed study, a multiple linear regression will be conducted taking GDP as dependent variable and unemployment and inflation as independent variables. The sign and magnitude of the regression coefficients indicates how inflation and unemployment affect GDP of Australia. Finally the statistical significance of the variables will be tested to accept or reject the proposed hypotheses.

Sequential Activities/ Period	Week 1	Week 2	Week 3 &4	Week 5 & 6
Identification of problem	ü
Research design		ü
Data collection		ü	ü
Data Interpretation			ü
Publication process				ü

Conclusion

This research is based on establishing the effect of unemployment and inflation on the GDP of Australia. From various past researches, it has been observed that unemployment has a negative impact on the GDP of a country. Inflation on the other hand has both positive and negative impacts based on the economic condition of the country. With the help of correlation and regression analysis, the impact of unemployment and inflation can be measured on the GDP of Australia. This research will be conducted from a secondary data collected from the ABS Website.

References

Akeju, K. F., & Olanipekun, D. B. (2014). Unemployment and economic growth in Nigeria. Journal of Economics and Sustainable Development, 5(4), 138-144.

Ayres, K., Belasen, A. R., & Kutan, A. M. (2014). Does inflation targeting lower inflation and spur growth?. Journal of Policy Modeling, 36(2), 373-388.

Ball, L., Jalles, J. T., & Loungani, P. (2015). Do forecasters believe in Okun’s Law? An assessment of unemployment and output forecasts. International Journal of Forecasting, 31(1), 176-184.

Bhattacharya, R. (2014). Inflation dynamics and monetary policy transmission in Vietnam and emerging Asia. Journal of Asian Economics, 34, 16-26.

Eggoh, J. C., & Khan, M. (2014). On the nonlinear relationship between inflation and economic growth. Research in Economics, 68(2), 133-143.

Gomez, R. (2015). The economy strikes back: Support for the EU during the Great Recession. JCMS: Journal of Common Market Studies, 53(3), 577-592.

Law, S. H., & Singh, N. (2014). Does too much finance harm economic growth?. Journal of Banking & Finance, 41, 36-44.

Madurapperuma, M. W. (2016). Impact of inflation on economic growth in Sri Lanka. Journal of World Economic Research, 5(1), 1-7.

Ozturk, S., Sozdemir, A., & Ulger, O. (2014). The effects of inflation targeting strategy on the growing performance of developed and developing countries: Evaluation of pre and post stages of global financial crisis. Procedia-Social and Behavioral Sciences, 109, 57-64.

Sadiku, M., Ibraimi, A., & Sadiku, L. (2015). Econometric estimation of the relationship between unemployment rate and economic Growth of FYR of Macedonia. Procedia Economics and Finance, 19, 69-81.

Seth, A., & Araf, Y. D. (2018). The Impact of Unemployment on Economic Growth in Nigeria: An Application of Autoregressive Distributed Lag (ARDL) Bound Testing. Sumerianz Journal of Business Management and Marketing, 1(2), 37-46.

Shahid, M. (2014). Effect of inflation and unemployment on economic growth in Pakistan. Journal of economics and sustainable development, 5, 15.

Singla, A., Ahuja, I. P. S., & Sethi, A. P. S. (2017). The effects of demand pull strategies on sustainable development in manufacturing industries. International Journal of Innovations in Engineering and Technology, 8(2), 27-34.

Soylu, Ö. B., Çakmak, ?., & Okur, F. (2018). Economic growth and unemployment issue: Panel data analysis in Eastern European Countries. Journal of International Studies Vol, 11(1).

Thanh, S. D. (2015). Threshold effects of inflation on growth in the ASEAN-5 countries: A Panel Smooth Transition Regression approach. Journal of Economics, Finance and Administrative Science, 20(38), 41-48.