Relationship between Inflation and Unemployment. Economics Essay

Relationship between Inflation and Unemployment
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Relationship between inflation and unemployment
Inflation and unemployment rate are the most important indicators in an economy and the key determinants of underdevelopment. The two elements have socio-economic impacts on the population of the country where the process occurs. Unemployment is the significant waste or underutilization of a country’s manpower resources. Kasseh (2018), argues that high unemployment represents an inefficient economy that is operating below its full capacity. Consequently, this leads to lower output, declining incomes, reduced purchasing power, and the inability to raise living standards. A rise in unemployment causes a negative multiplier effect as well as reduced economic growth (Ormerod et al., 2013). On the other hand, inflation increases aggregate money income in the community leading to greater production and increased spending. Inflation represents the proportion of change in the prices of goods and services (Alisa, 2015). Inflation leads to higher interest rates, reduced exports, decreased savings, and inefficient government spending, and increased taxation.
The connection between inflation and unemployment has been explained by different researchers using diverse models such as the Philips curve model, error correction model, and Vector Autoregressive techniques. Traditionally, the relationship between these two elements has been an inverse correlation. In her study Alisa (2015), realized that higher inflation rates motivate workers to work, which in turn generates more employment opportunities as many firms are motivated by the higher prices to increase their production. In a similar way, Orji et al., (2015), observed that as the economy experience rise inflation, the output increases proportionally. Also, as the economy edges to full employment, inflation also rises. This, in turn, creates more employment, as many firms are willing to increase their production capacity. Therefore, with increased economic growth in the short term, the inflation rates increase while the unemployment rate declines.
Alban Philips, the founder of the Philips’ Curve model, is believed to be the greatest contributor and first economist to present fascinating evidence on the inverse association among inflation and unemployment. In his research, Philips analyzed the connection between unemployment and the rate of change of wages in the United Kingdom for the period between 1861 and 1957. In his findings, Philips identified that a change in wages and salaries is linked to the level of unemployment as well as the rate of change of unemployment (Alisa, 2015).
Equally, Philips postulated that when the demand for labor increases, the number of unemployed workers decreases. In this respect, employers increase wages in an effort to maintain their workers as well as attract more employees into their firms. On the flip side, Philips realized that as the demand for labor decreases, unemployment increases. As a result, employees agree to take lower wages than the prevailing rates leading to decreased wages rates. However, Philip also realized that between 6-7% unemployment rates, the wage level is constant, and an increase ...