ECO203 Assignments Week 5 - Final Paper- Expansionary Economic Policy

Week 5 final paper

The Short-Run and Long-Run Relationship Between Unemployment and Inflation

ECO 203 Principles of Macroeconomics

Instructor: Robert Gordon

1/21/19

The Short-Run and Long-Run Relationship Between Unemployment and Inflation

Macroeconomics analyzes the effects of the economy’s growth which inquires the aggregate changes of employment and inflation, “Economics focuses on the consumption, production, and use of scarce resources by individuals and groups” (Amacher, 2019).

Unemployment and inflation are some of the macroeconomic issues that can be a reason why the economy fails. With low employment people won’t be able to make a living and inflation will continue to rise. Unemployment occurs when the aggregate is at a low level but when the aggregate is at a high-level inflation happens. “As long as aggregate supply is stable and upward sloping, shifts in aggregate demand create a policy trade-off between inflation and unemployment” (Amacher, 2019). Aggregate supply and demand relate to inflation and unemployment because price levels demand on the shift of the curve while unemployment focuses on output.

Macroeconomics goal is to focus the attention on getting the community to get full employment. Not everyone will be employed but there will be less governmental spending. With the government not spending as much this will cause economic growth. According to the text “An economy is at full employment when 94% of those who want to work are employed. Another definition of full employment is that the number of job seekers is approximately equal to the number of job vacancies—the U.S. job market index otherwise known as the help wanted index” (Amacher, 2019). If inflation continues to rise the economy will be at risk. If inflation constantly increases, it will impact the people causing them to go in a bind because the cost of living is affected. According to Wells, “The inflation target is symmetrical, the economy - in particular, the relationship between employment/unemployment and inflation in the region of the non-accelerating inflation rate of unemployment (NAIRU) - most certainly is not.

When price disinflation occurs, the monetary authorities may find it difficult to assess the extent to which output is deviating from desired levels. Hence, inflation-targeting in a demand-shocked economy risks imparting a deflationary bias to the real economy” (Wells, 1998).  They believe that inflation increases at a fast paste and when the activity levels are lower than normal it decreases. While inflation increases its is causing problems in the economy. The people in the economy are affected by inflation because the costs of goods and services increases people are having trouble affording items. Which is causing borrowing to increase faster and put us in a Recession. People may have to sell their homes at a lower price which happened in 2008 causing the Great Recession. Unemployment rates will rise because the demand for good and services are increase. Production in companies will decrease because they won’t have the labor to produce more. People are going to be constantly looking for jobs and just nor enough jobs for all the people. “Monetary policy targeted on inflation and fiscal policy focused on budget consolidation - has been little short of disastrous for the real economy. Not only has the composition of output between the internationallyexposed and sheltered sectors become dangerously unbalanced, but now the level of economywide gross domestic product is under threat as well” (Wells, 1998).

In the long run there is no tradeoff between inflation and unemployment and in the short run unemployment decreases while inflation increases. The changes in unemployment are because of the changes in output. People being unemployed is causing them to borrow and inflation increases because governmental spending is getting out of hand. The community is relying on the government to get by living off the assistance.  Inflation is only good to the economy when there are more aggregated demand and people are employed. The cause people to spend on more goods and services rather the government. According to the text, “A one-time change in the price level is not inflation, which consists of a sustained and continuous rise in the price level” (Amacher, 2019). People in the long run adjust to what is happening in the economy to benefit them.  According to Amacher, “When both the aggregate demand and long-run shift to the right, output clearly increases. The effect on unemployment depends on whether output grows faster or more slowly than the labor force, and the effect on the price levels demands on which curve shifts farther or faster” (Amacher, 2019). While there is unemployment the cost for goods in services increase and governmental spending occurs because everyone is borrowing and unable to pay back.

According to Singh, “Interest rate causes stock market index in both long run and shortrun. The findings show the evidence of causality from stock price index to wholesale price index in both long-run and short run but not other way around. Furthermore, it is observed from the findings that money supply causes stock prices only in the long-run but not in short run (Singh. 2016). While interest rates are low this benefits the people to be able to spend more in goods and services. Also, when interest rates are low this causes less borrowing due to the purchasing prices. People have more room to afford. If interest rates increase this leaves people, no room to spend.

The Phillip’s curve is used to show the rates of unemployment and inflation throughout the years. As Aggregated demand increases unemployment can fall because the demand for higher wages is affecting companies, so companies are looking for skilled workers. Prices for goods and services increase because people wages increase.

According to Amacher, “When aggregate demand is increasing, business firms expand output and increase employment. As the unemployment rate falls, it becomes increasingly difficult to hire qualified workers at the prevailing wage rates” (Amacher, 2019.) Skilled workers are struggling o find work because companies are hiring the bare minimum because they do not want wages to increase. Companies don’t want to be able to pay more for un-qualified worker. While unemployment is high causing plenty of people searching for work, but the amount of people exceeds the amount of jobs that are available. The Phillip’s curve was controlling the relationship between unemployment and inflation.

The back story behind the Phillip’s curve was when the unemployment rate was high people were suffering and, in the need, to look for jobs just to make a living based of their financial situation. So higher wages weren’t needing to be offered to anyone in the organization because wages were low. There was a negative impact on the Phillips curve because people were suffering. “The Phillips curves was used to lower the rate of unemployment by having a higher inflation. Even though they though the Phillip’s curve would be a great hypothesis, the inflation increased and so did the unemployment in the United States” (Chen, 2018).

In the short run a vertical supply curve is demanded. Businesses are reducing output while inflation increases. Its causing business to cut back on wages and only looking for quailed workers. “In the short run, expansionary policy could reduce unemployment at the cost of an increase in the inflation rate. But, Friedman argued, the new inflation–unemployment combination is not stable. Lower unemployment is achieved only if workers expect zero inflation” (Amacher, 2019).

No matter what society were in the unemployment rate will continue to fluctuate hoping to keep it on a lower side. I think the Phillip’s curve will still help today’s society when it comes to have a Great Recession. During a recession the current rate of unemployment is higher than the actual rate. People are looking for jobs but failing. The Monetary policymakers like to use the Phillip’s curve for high inflation and low unemployment. According to Hornstein, “the Phillips curve have been at the core of monetary policymaking since the 1960s. at the end of the 1970s after years of persistently high inflation and high unemployment, monetary policymakers moved to lower the inflation rate. At the time that U.S. inflation started to decline in the 1980s there was a resurgence of interest in business cycle analysis.” (Hornstein, 2008). In the long run when the curve is shifting to the right inflation is increasing. In the short run it will curve up and left. When aggregate demand decreases unemployment occurs but if aggregate demand increases prices and wages increase. A Phillip’s curve exists in the short and long run. According to Ho,

“The classical Phillips curve shows a negative relationship between inflation and unemployment. The thresholds in unemployment were 5.00% and 6.54%. By estimating the Phillips curve using these thresholds, we found that the relationship between inflation and unemployment is only negative when unemployment is lower than 5.00%. The negative relationship turned positive when unemployment was between 5.00% and 6.54%. Inflation and unemployment are unrelated once a threshold of a 6.54% unemployment rate is surpassed.” (Ho, 2018).

The federal Reserve monitors unemployment and inflation by gradual increases in the target range for federal funds that is consistent with the economy. The Federal reserve helped to keep interest rates low and keep the economy from falling. When inflation became a problem and kept increasing the federal reserve had to increase interest rates. The economy became weak and a recession was occurring. the Gramm–Rudman–Hollings Act in 1985 came in effect when the ability of spending became uncontrollable. So, congress passed the act to put it under a budget plan. “The 1980s experienced a long peacetime expansion, but in the early 1990s, inflation began to rise, and the Federal Reserve began to raise interest rates. These increases— combined with the 1990 oil price shock, the debt accumulation of the 1980s, and growing consumer pessimism—weakened growth” (Amacher, 2019).

Macroeconomics was studying the situation of the economy in ways to better it so it does not go through another recession. “In macroeconomics, you look at the level of prices and output for the economy, using aggregate demand and aggregate supply as the main tools. Even though microeconomics and macroeconomics are often studied separately, they are closely related” (Amacher, 2019). The United states was uncontrol due to the over spending, unemployment rates increasing. Congress developed many plans to try to the country in order.

References:

Wells, J. (1998, Dec 11). UK government’s economic illiteracy. Financial Times Retrieved from https://search-proquest-com.proxy-library.ashford.edu/docview/248687327?accountid=32521

Singh, G. (2016). The impact of macroeconomic fundamentals on stock prices revised: A study of indian stock market. Journal of International Economics, 7(1), 76-91. Retrieved from https://search-proquest-com.proxy-library.ashford.edu/docview/1828144018?accountid=32521

Chen, S., & Desiderio, S. (2018). What moves the beveridge curve and the phillips curve: An agent-based analysis. Economics, 12(2), 1-30,30A. doi:http://dx.doi.org.proxylibrary.ashford.edu/10.5018/economicsejournal.ja.2018-2

Hornstein, A. (2008). Introduction to the new keynesian phillips curve. Economic Quarterly - Federal Reserve Bank of Richmond, 94(4), 301-309. Retrieved from https://search-proquestcom.proxy-library.ashford.edu/docview/204877765?accountid=32521

Ho, S., & Njindan Iyke, B. (2018). Unemployment and inflation: Evidence of a nonlinear phillips curve in the eurozone. St. Louis: Federal Reserve Bank of St Louis. Retrieved from https://search-proquest-com.proxy-library.ashford.edu/docview/2056107300?accountid=32521

Amacher, R., & Pate, J. (2019). Principles of macroeconomics (2nd Ed.). Retrieved from https://content.ashford.edu/

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