The link between inflation and unemployment economics essay
Some economists even pointed out that it is the inefficiency of policy in the long-run that led to the Great Stagflation.
Changes in aggregate demand translate as movements along the Phillips curve. Additionally, a different explanation has also been suggested by New Keynesian economists, which is becoming more and more popular nowadays.
With more people employed in the workforce, spending within the economy increases, and demand-pull inflation occurs, raising price levels. Because of the higher inflation, the real wages workers receive have decreased.
They will be able to anticipate increases in aggregate demand and the accompanying increases in inflation. The natural rate hypothesis, or the non-accelerating inflation rate of unemployment NAIRU theory, predicts that inflation is stable only when unemployment is equal to the natural rate of unemployment.
The Phillips curve argues that unemployment and inflation are inversely related: as levels of unemployment decrease, inflation increases.
However, eventually, the economy will move back to the natural rate of unemployment at point C, which produces a net effect of only increasing the inflation rate.
Unemployment and inflation macroeconomics
Changes in aggregate demand translate as movements along the Phillips curve. During the period from As aggregate demand increases, inflation increases. The natural rate hypothesis was used to give reasons for stagflation, a phenomenon that the classic Phillips curve could not explain. In conclusion, since when the Phillips Curve was discovered, it has received a lot of attention by economists. Shifting the Phillips Curve with a Supply Shock Aggregate supply shocks, such as increases in the costs of resources, can cause the Phillips curve to shift. Individuals will take this past information and current information, such as the current inflation rate and current economic policies, to predict future inflation rates. As such, in the future, they will renegotiate their nominal wages to reflect the higher expected inflation rate, in order to keep their real wages the same. Key Terms Natural Rate of Unemployment: The hypothetical unemployment rate consistent with aggregate production being at the long-run level. Because in the short-run, before the government conduct the expansionary policy, people have adjusted their inflation expectation according to the information they get, and they will request higher wages. Because wages are the largest components of prices, inflation rather than wage changes could be inversely linked to unemployment.
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