Question:
Describe the Relationship between inflation and unemployment?
In the past years it has been said that the economic condition of the countries have encountered critical changes. It can be seen that there has been an increase in the connectivity between the nations after the globalization process. An extensive impact has been created by the financial recession of 2008- 2009 on the connected economy of the various countries. Economists have suggested that there are a numerous number of factors that affect the economy of the country and these factors are considered to be the performance indicators of the country’s economic position. The major factors that act as performance indicators of the countries are namely the inflation rate changes, unemployment rate, GDP growth rate, per capita income and also the national output of the country (Media, 2015). The government of the countries implements different measures with the help of the fiscal and monetary policies of the country for improving and correcting the flaws within the economic indicators.
The assignment here aims to determine the relationship between the various economic indicators and ascertain the effectiveness of the various measures taken by the government to improve the economic conditions of the different countries (Statista, 2015).
The two major economic performance indicators are namely the inflation rate and the unemployment rate. Inflation may be defined as the phenomenon where the price levels of all commodities increase (Ravenna and Walsh, 2012). Unemployment is the rate at which the percentage of citizens who are seeking for job opportunities are staying vacant without any employment opportunity. With the increase in the number of population the unemployment rate of the country also increases. Inflation is an undesirable situation for the country because the inflation leads to increase in the price of the commodities which reduces the real income of the consumers and also reduces the purchasing power of the consumers. Hence the government takes various measures in order to control the inflation rate. Moreover high unemployment rate is also undesirable for the country because the higher the unemployment rate more the population of the country will remain out of service. This in turn increases the financial and social burden of the country and the number of dependent population increases which contributes to the degradation of the economic condition of the country.
The economists have suggested that there is a trade off relationship between the inflation and the unemployment rate. There exists negative relationship between the inflation and the rate of unemployment. This inverse relationship is depicted with the help of the Philip’s curve. The curve states that when inflation rate increases the unemployment rate falls and vice versa. The locus of various combinations of inflation rates with corresponding unemployment rate gives rise to the Philips’s curve. However the negative relation between the two factors is majorly seen in the short run and the curve doesn’t hold good at the time of long run (Media, 2015). The following diagram of the Philip’s curve can show the relation between the two factors in short run.
From the above figure, it has been found that, unemployment is been decreased if the government will be looking to implement the inflationary polices within the economy. There has numerous occasions during the market crash of 2008 most of the companies went on job cut which has crushed employees loyalty towards their own organizations (Statista, 2015). Inflation plays one of the major part in the creating wealth for the nations. Rising inflation various nation like EU and North America indicates economy is been not been able to recovered from the 2008 market crisis. Inflation here depicts the rise in the process of goods and services . However, it can also be trend as the too much money is chasing few goods. The price level of the goods are been increasing due to the rise in the inflations. Most of the nations like India and China are able to save themselves from the inflations because of the nature of saving habits and the strict norms of the regulators.
With the help of following diagram the concept of the aggregate demand and aggregate surplus will be clear.
As per the above, given Philip curve, inflation is only for the short run rather than long runs.
Regulators and Government Involvement
Governments of UK are very keen on reducing the inflation rate in order to increase its GDP rate. This depicts that government has uses various tool like low industrial loan and low in interest on the SME business. Apart from that, there has been numerous other tools which will help to reduce the inflation in order to generate the employment opportunities and developing the infrastructure to take giant leap in the shaping the future of the nations. There are two major factors which influence the inflation are social and economical. The government of the various nations are bringing the economy stable by intervening in the monetary and fiscal policy which will give control over the country production and supplies. Fiscal policy includes the taxation policy and the monetary policy includes the CRR, SLR and WPI are some of the major indicators of the measuring the monetary policy. There has been several examples which shows that, most of the countries are looking to create stringent CRR rates to ease the fiscal policy for the current business trend.
From the above, it can be seen that, most of the nations are been affected by the inflation s rate within their nations. UK inflation rate been fluctuating rather than being constants as the per the Mr. Cameron, inflation rate in 2013 will be ease with the coming years because the current inflation rate of the UK is 1.34% as per the London chamber of commerce. The takes lots of giant step to recover from the inflation are which decreasing with the changing years. Both inflation rate and the unemployment rate of the UK is been fluctuating since 2008 economic turmoil (Tradingeconomics.com, 2015)
Inflation and unemployment can be considered as two major performance indicators in an economy as it can help in estimating the performance of the economy in an industry. These factors can significantly affect the growth and development of an economy. So, it is evident that there is a relationship between the inflation, unemployment and the growth rate of the economy. The inflation, unemployment and the growth trends in India can be discussed for the past few years and their relationship can be established as well.
Inflation rate can be estimated as the general rise in the price level in an economy. It is evident that India is related with various nations as the trade relations increase the interconnectedness and the financial relation increases with the foreign direct investment. Inflation can be of two types. One is cost-push inflation and another is demand-pull inflation. Thus the shortage or excess in demand and supply of the goods and services can lead to inflation in an economy. It is seen that the inflation rate was 5% in December 2014. In November 2013, the inflation rate was recorded at all time high rates of 11.16%. In India, the Wholesale Price Index (WPI) is considered as one of the main measures that are used for measuring inflation. Here Consumer Price Index (CPI) is also considered as another measure for inflation. In the following table, various aspects of prices are given (Media, 2015).
Source: (Tradingeconomics.com, 2015)
In the diagram below, the inflation rate of India is shown from the year 1959 to 2013. From the diagram it can be opined that in earlier decades the inflation rate fluctuation has been higher whereas in recent years the fluctuation in the rate of inflation has been lowered. It is seen that the CPI was as high as 14.97% in 2009 and the main cause of such high rate of inflation is the global financial crisis.
Source: (Media, 2015)
Here the trend of unemployment can now be evaluated. When people look for jobs but they do not find any jobs, they are termed as unemployed. Thus it can be said that unemployment is one of the undesirable indicators of an economy. The unemployment can increase if the population density is very high in an economy. Such issues are faced by India as the population density in the country is very high. From 1983 to 2012 the average rate of unemployment is 7.58%. In 2011, the rate of unemployment was 6.30% in India. In 2012, the rate of unemployment decreased to 5.20% (Statista, 2015). In 2009, the unemployment rate reached 9.40% which is all time high unemployment rates in India. The main cause of such trend is the global financial crisis. In the following diagram the unemployment rate in India is shown from 2000 to 2014.
Source: (Tradingeconomics.com, 2015)
It is seen in the diagram that from 2000 up to 2006, the rate of unemployment has increased steadily. After that the rate of unemployment has reduced till the year 2008. After that the unemployment rate has increased sharply till 2010. Such rise in the unemployment rate is due to the prevailing condition of global financial crisis. After 2011, there is a sharp decline in the unemployment rate in India. In the following table, the different aspects of unemployment are shown for India.
Source: (Tradingeconomics.com, 2015)
It can be contended here that the government intervention and implementation of various measures is the main reason for the decline in the unemployment rate in the economy. The government of India has taken the initiatives to provide better job opportunities to the people. It is evident that the job opportunities have increased in the government as well as in the private sector. It is already established that there is a negative relationship between the inflation and unemployment. In the following table the trend of unemployment and inflation is shown for India for the year 2002-2013.
Source: (Indexmundi.com, 2015)
In the following diagram the trend line of inflation and unemployment can be shown. In the diagram it can be seen that there is a difference in the variation of the two variables. From 2007-2007, it is seen that when the inflation rate increases the unemployment rate falls and thus it can be said that the Phillips relations is true for the segment. On the other hand, for the later segment such relation is not true as both the variables has increased and decreased simultaneously together.
Now the growth trends of India can be discussed here. It is known that the growth rate is the ultimate indicator of the growth and development of an economy. The GDP growth rate is referred as the change in the GDP of an economy. The growth rate of India was 5.30 in 2014. From 1951 to 2014, the average annual growth rate was 5.82%. In 2010 the growth rate reached 11.40% which is all time high growth rate. The GDP annual growth rate of India is reported by The Ministry of Statistics and Programme Implementation (MOSPI). The annual growth of India is shown in the following diagram from 2000 to 2014. In the diagram it can be seen that there has been fluctuations in the growth of India. From 2005 till 2007 a steady growth rate is seem and then the growth rate has sharply declined around 2008 and it again increased in 2010. It is seen that after 2012, there has been steady decline in the growth rate (Economicsonline.co.uk, 2015).
Source: (Tradingeconomics.com, 2015)
In the following table the inflation rate, the unemployment rate and the growth rates of India from 2002 to 2013 is shown.
Source: (Data.worldbank.org, 2015)
In the following diagram, the trend line of inflation, unemployment and the growth rate of India are shown from 2002-2013.
It is known that the aggregate supply curve is the total supply of goods and services by the producers in an economy at considerable price levels. So the aggregate supply curve can be referred as the locus of the combinations of price level and the equilibrium quantities of goods that are provided by the suppliers. There are three main ranges of the aggregate supply curve and these are Keynesian, Intermediate and classical.
The ranges of the aggregate supply curve are shown in the diagram. From the diagram it is seen that in recent times, there is a positive relationship between the inflation and GDP growth rate. That means when the inflation has increased, the growth rate has also increased. So India is operating in the intermediate range of the supply curve.
Consolo and Favero (2009) argued that monetary policy is one of the most important and affective as well as efficient tools of government that used during changes of various economical methods. Using the monetary policy, monetary country is able to control the economy especially the supply of money in terms of stability. Apart from that, monetary policy allows in introducing method that generate economy growth for the country. On the other hand, Gertler and Karadi (2011) argued that monetary policy target to the inflation and interest rate in terms of increasing economy growth and stability. On the contrary, Bhamra et al. (2011) cited that monetary policy will be the expansionary or contraction for the nation. According to Deviatov and Wallace (2009), expansionary monetary policy helps in increasing supply of money or the nation and creates a potential impact over economy of the country. On the other hand, McGettigan et al. (2013) assumed that contractionary monetary policy indicates the lower money supply in the nation.
Expansionary monetary policy increases the supply of money and improves the growth rate of economy for a particular nation in the world. Apart from that, expansionary monetary policy also allows the nation in stabilizing their economy growth rate during the time of recession via lowering down the inflation and interest rate of the nation. Moreover, expansionary monetary policy leads to increase the inflation rate for nation during availability of economy resources via reducing the value of money. Ravenna and Walsh (2012) suggested that expansionary monetary policy helps in reducing unemployment rate and increase higher inflation rate. On the other hand, Pedram (2011) acknowledged that expansionary monetary policy also increase the inflation rate for the nation by decreasing unemployment rate. Through this process one country is able to increase their supply of economy and maintain continuous economic growth. Apart from that, expansionary monetary policy increases the cost of capital and bonding prices for a nation from the point of view of lower interest rate. Expansionary monetary policy also affect in the exchange rate in a nation. However, use of expansionary monetary policy, one nation can increase foreign currency due to high demand for domestic currency fall. Expansionary monetary policy is also allowing the nation to increase value for money within their domestic region.
Contractionary monetary policy is implemented due to lowering down supply of money regarding economy of the country. Majority of government in different part of the world implement contractionary monetary policy for different types of measurement. Majority of government use conractionary monetary policy to sell the securities regarding economy in open market. Apart from that, contractionary monetary policy increases the requirements of reserve bank in terms of federal discount rate. Thus, contractionary monetary policy allows the government of one country in measuring interest rate and fall of investment. Through this process, government of the country can increase their domestic currency rate and demands for higher foreign currency reduce in open market. Furthermore, this process controls the exchange rate for the domestic currency as well as foreign currency within the open market. Form this point of view, it has been utilised that contractionary monetary policy increased the rate of interest and decreased the price of bonds as well as reduce the capital investment.
Fender (2012) depicted that monetary policy significantly effect in the economy of one country by influencing the economic indicator of that particular country. The monetary policy implemented within the economy of one country by the authorities of monetary policy of the nation. However, monetary policy has potential relationship between the supply of money and interest rate. Johansson (2012) explained that monetary policy is also affected by the growth rate of economy worldwide. Howeve,r GaliÌ (2010) argued that monetary policy also has potential impact in reducing issues in the current economy of one country. Due to high wage of demand, inflation rate is triggered. Therefore, it increased the cost of capital for the nation along with their entire business firms. Therefore, Braggion et al. (2009) suggested that in these types of scenarios, monetary policy is not appropriate to increase inflation and interest rate as well as generates economic stability. Adam and Woodford (2012) argued that in order to increase the economy growth, nation could implement the open market operation instead of monetary policy. There are several countries in the world where the government implements the open market operations in terms of measuring the desirable result of economy. For instance, several governments in various countries use monetary policy for achieving the economic stability during the financial crisis. Federal Reserve helps in holding the long-term securities in open market due to maintain interest and inflation rate.
Conclusion
From the above finding, it has been understand that competition is high at global level. Therefore, in order to maintain the high competitive advantage among the others, organisations have to develop or adopt several policies. For the developing country such as India, China, South Africa needs to maintain specific economic policy for emerging economic growth rate. Therefore, government of the country has to take responsibility for measuring properly the economic performance from the point of view of interest rate and inflation rate. In case of India, inflation rate, interest rate, growth rate and unemployment rate has been measure properly by using the monetary policy.
References
Adam, K. and Woodford, M. (2012). Robustly optimal monetary policy in a microfounded New Keynesian model. Journal of Monetary Economics, 59(5), pp.468-487.
Bhamra, H., Fisher, A. and Kuehn, L. (2011). Monetary policy and corporate default. Journal of Monetary Economics, 58(5), pp.480-494.
Braggion, F., Christiano, L. and Roldos, J. (2009). Optimal monetary policy in a ‘sudden stop’. Journal of Monetary Economics, 56(4), pp.582-595.
Consolo, A. and Favero, C. (2009). Monetary policy inertia: More a fiction than a fact?. Journal of Monetary Economics, 56(6), pp.900-906.
Data.worldbank.org, (2015). GDP growth (annual %) | Data | Table. [online] Available at: https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?page=2 [Accessed 17 Jan. 2015].
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