Relationship between Inflation and Unemployment

1. Explain whether there is a relationship between inflation and unemployment. Should government interfere and reduce inflation and unemployment? provide real life examples.

2. Using your home country as a case study outline and analyse inflation, unemployment and growth trends. Identify what range of the aggregate supply curve your country is operating in.

3. Explain how monetary policy can influence an economy, including the exchange rate and employment levels.

In the past few years, the economic condition has encountered critical changes. Obviously, the connections between various countries have expanded enormously, particularly after the wave of globalization. Hence, the risk or danger associated with financial breakdown in a specific nation may affect upon different nations including that of the increment on the financial connections among nations. It has been observed that the global financial crisis during 2008 to 2009 had created significant impact on the economies of the individual countries by virtue of the interconnection (Mankiw, 2007). Generally, there are various elements that prompt significant effects upon the development and growth of the nations, and all these components are also referred as the indicators of the financial performance. All these components include the inflation, rate of unemployment, growth rate of GDP, output of the economy, per capita income and so forth. Each of the components indicates the performance of the economy. The legislature is additionally in charge of embracing distinctive measures in setting to budgetary strategies to upgrade the monetary conditions (Krugman and Wells, 2009). The key goal of this paper is to reflect upon the connection between distinctive markers and additionally the measures which are being adopted by the individual government for enhancing the states of economy.

It is evident that the two major indicators of the economic performance a nation are inflation and rate of unemployment. Inflation can be defined as the increase in the price level in a particular economy. On the other hand, unemployment can be described as the number or percentage of people who are searching for job in order to earn a livelihood but unable to get one. The people who are looking for jobs but cannot get an opportunity to work are referred as unemployed people (Lehmann, 2011). The annual increment in the rate of unemployment in the world is considered for calculating the overall global rate of unemployment. It has been found that the annual increment in the rate of unemployment across the world leads to growing number of unemployed people which is not at all desired as it affects the economy in a negative way. Hence, it can be stated that inflation rate and unemployment rate are the major two indicators of the economy (Mankiw, 2007).  High rate of inflation is not desirable for the nation as it leads to significant increase in the price of goods and services. Hence, the suffering of common people increases. Additionally, high rate of unemployment is also not appreciated by the society as the burden of unemployed people increases (Hubbard and O’Brien, 2006). Thus, high level of inflation as well as unemployment has a negative impact on the economy of the nation.

Government Intervention

Various research papers have provided evidence regarding the significant trade off which exist between inflation rate and unemployment rate of the economy. It has been found that there is a negative relationship between the unemployment rate and inflation (Lanne and Luoto, 2013). The inverse association between these two factors can be demonstrated with the aid of Philips curve. In short run, if inflation rate increases, unemployment rate declines. Hence, it can be stated that there is a negative relationship between unemployment rate and inflation in the economy. However, this relationship does not hold in long run. The Philips curve has been illustrated below in order to depict the relationship between unemployment rate and inflation of an economy (Krugman and Wells, 2009).

(Phillips Curve, Source: (Hubbard and O’Brien, 2006))

From the above diagram, it can be implied that the unemployment rate can be decreased in a nation when the government adopts effective policy for managing inflation. Hence, it is true that the inflation cannot be completely undesired in an economy. Economists have segmented inflation into two categories, demand pull and cost push inflation. Demand pull inflation occurs when the total demand of the economy enhances which means the demand curve shift to the right side. Consequently, with the increase in demand, the price of the products and services will increase in the economy (KELLY, 2000). The production will also increase and the business organization will require employing more workers in order to satisfy the growing level of demand (DoÄŸrul and Soytas, 2010). Hence, the unemployment rate will be declined. In the following diagram, the impact of demand pull inflation has been represented:

(Source:  (Abel and Bernanke, 2001))

According to Milton Friedman, the Philips Curve holds only in short run. In case of long run, the policy of inflation will not address the issues regarding the unemployment of the nation. Government Intervention

It has been recognized that high level of unemployment as well as inflation are not desired within an economy (Inflation and unemployment in economies on the move, 2000). Nonetheless, a trade off is found to be existing between inflation and unemployment which implies that increase in one of the variables will decline the other. Consequently, imperatively successful measures are to be taken for keeping up the relentless parity between unemployment and inflation, and in this way it helps in amplification of the financial and additionally social welfare inside an economy. Thus, it can be stated that the government intervention is significant for executing diverse policies and procedures for declining the level of unemployment in an economy. This intervention is found to be very useful in keeping up the rate of inflation within the tolerance level. Government may mediate inside an economy with the backing of the different financial policies and procedures. Tax rate and government expenditures are considered to be monetary instruments. Again, the fiscal measures include the change in interest rate, change in the tax rate etc. These may be used for enhancing or diminishing the unemployment and inflation rate.

Inflation, Unemployment and Growth Trend in Australia

In this context, various examples can be cited which has demonstrated that the negative association between the inflation rate and rate of unemployment. In the following diagram, the inflation and unemployment rate of Australia from 2002 to 2013 has been presented to illustrate its trend:

(Unemployment rate and Inflation of Australia form 2002 to 2013, Source: Created by Author)

It can be observed from the above graph that increases in the rate of inflation leads to decline in the unemployment rate in Australia. However, some exceptions are also observed which can be explained with the aid of other economic factors. The government of Australia has been undertaking effective measures which helped in controlling both the inflation and unemployment rate in the economy.

It has been observed that in various nations, inflation and rate of unemployment is considered to be the major tow indicators of the economic performance of the nation. The growth and development of the nation is significantly reliant upon these variables. It has been found that an association is prominent among the inflation rate, growth of the economy and rate of unemployment (Warne and Vredin, 2006). In this section, the focus will be shifted towards the historical data regarding inflation rate, growth rate and rate of unemployment in Australia for establishing the relationship between these three factors.

It has been found that the Australia is one of the most important developed nations off the world. The interconnection with other countries is found to be significant for the economy of this nation. It has been observed that Australia has been maintain good trade relationship with the other nations and focused on enhancing foreign direct investments (Warne and Vredin, 2006).  Wholesale Price Index (WPI) and Consumer Price Index (CPI) are considered for estimating the inflation of the country. It has been found that the inflation rate is 1.70%. In the previous quarter, the inflation rate has dropped to 2.3% due to sharp decline in the price of electricity facilitated by abolition of the carbon tax. From the following table, it has been found that in the latest quarter price of the food has declined. According to the Reserve Bank of Australia, the targeted range for the annual inflation is estimated to be 2 to 3 %. The present rate of inflation demonstrates that in order to meet the inflation target in the following years, the central bank of Australia will focus on changing the rate of interest (Creighton, 2014).

(Source:  (Tradingeconomics.com, 2015))

In the following diagram, the historical rate and trend of the inflation rate of Australia has been depicted. It has been found that the inflation rate of Australia has been stable over the past few years. In 2008 and 2009, the inflation rate has increased due to the global financial crisis. Presently annual rate of inflation rate of Australia is moderate and within the target rate set by the Reserve Bank of Australia.

(Source:  (Tradingeconomics.com, 2015))

Now, the unemployment rate of Australia needs to be assessed. High level of unemployment rate is not desired by any income as it leads to various negative impacts on the economy as well as society.  In November 2014, the unemployment rate of Australia was estimated to be 6.3% which is highest since 2002 (Qgso.qld.gov.au, 2015). Though 42,700 jobs were added to the Australian economy in October 2014, the unemployment rate rose by 0.1% in the following month. According to economists, the RBA is under extensive pressure and they may focus on cutting the interest rate. It has been observed that for the last twenty years, Australia has not encountered recession. However, the nation is significantly struggling for facilitating a shift to the growth which will not be led by the mining sector. It has been anticipated that the decline in the growth rate of China may lead to the increase in the unemployment rate of Australia because China is the major trading partner for Australia (BBC News, 2014).

(Source:  (Tradingeconomics.com, 2015))

Source: (Sum, n.d.)

According to above mentioned chart, the unemployment rate in the last few years have been decreasing for improving the intervention of the government within the economy of the world. From various evidences, it is quite identifiable that the Australian National Government has undertaken few effectual measures to work against the alarming circumstances and also offer various job opportunities in the market of Australia. Apart from this, the increase in the multiple lateral industries especially in the private sector of Australian market has given various opportunities by increasing the job offers for all the deserving candidates.

Generally, there is a negative link between the unemployment rate and the inflation rate. Thus, it is important to identify the pattern of both the inflation rate and the rate of unemployment. In the below mentioned table, relevant information about the two mentioned factors is being provided from the year 2002-2013 (Fasenfest, 2014).

Source: (Rateinflation.com, 2015)

From the above graph that is depicting the relationship between the inflation rate and the unemployment rate identified from the year 2002-2007, since the rate of inflation is rising compared to the unemployment rate, the Phillips curve is significant (Roy, 2011).  Since the year 2008, the Philips curve relationship lacks in maintaining the inflation and the unemployment rate as both the factors have been rising and decreasing at the same period of time.

Source:  (Ruge-Murcia, 2004)

If looked at the above figure, it is clear that in 2001, the GDP was low and thereafter in the later years, there has been increase in the GDP steadily. In the year 2009, the GDP of Australia has been decreased. Due to this, the country had to face hard time in respect to their economy. However, slowly, there has been consistent rise in the GDP of the Australia.

Source:  (Data.worldbank.org, 2015)

The below shown graph demonstrates the pattern of three different economic factors of Australia from 2002-2013:

Source: Made By Author

Monetary policy can be termed as the actions undertaken by the RBA(Researve Bank of Australia) to have impact on the financial and the monetary conditions in the cash market of Australia. This would help the organization to meet the economic goals for sustainable growth and low inflation (Langdana, 2009). The Reserve Bank of Australia is mainly responsible for administrating and formulating the monetary policy. This would help to achieve the non-inflationary growth which is mainly targeted as cash rate. The main objectives of the monetary policy in Australia are to maintain the inflation rate between 2% to 3% and also full employment at the non-accelerated inflation rate of unemployment between 5% to 7%. Further, the aim is to improve the growth of economy between 3% to 4% for sustaining people’s welfare and also their living standards.

The decisions undertaken by the monetary policy mainly affects the performance of the Australian economy in future. The economic agents actually analyze the prices based on the expectation. The inflation expectations affect the interest rate and also the aggregate demand and supply. In determining the monetary policy, the role of RBA is to maintain the stability of the price, employment and also the welfare and economic prosperity of Australian people. Thus for achieving the statutory objectives, the bank has decided to set “inflation target” that is to keep the consumer price inflation upto 2-3%. This would help the country to control the inflation and also preserve the money value and also encourage long term sustainable growth.

The Reserve Bank makes various moves to guarantee the behavior of money related approach is straightforward. These steps incorporate articulations proclaiming and clarifying every fiscal arrangement choice, the arrival of minutes giving foundation to the Board’s approach thoughts, and editorial and examination on the monetary viewpoint gave through open locations and general distributions, for example, its quarterly Statement on Monetary Policy and Bulletin. The Reserve Bank will keep on advancing open seeing thusly. The Reserve Bank advances the soundness of the Australian monetary framework through overseeing and giving liquidity to the framework, and leading the Council of Financial Regulators (including the Reserve Bank, Australian Prudential Regulation Authority, the Australian Securities and Investments Commission and the Treasury).

The Payments System Board has express administrative power for installments framework dependability. In satisfying these commitments, the Reserve Bank will keep on distributed its investigation of monetary strength matters through its half-yearly Financial Stability Review. What’s more, the Governor and the Reserve Bank will keep on partaking, where fitting, in the advancement of budgetary framework arrangement, including any considerable Government surveys, or worldwide audits, of the monetary framework itself. The Reserve Bank’s order to maintain budgetary dependability does not compare to a certification of dissolvability for money related foundations, and the Bank does not see its asset report as being accessible to help bankrupt establishments. On the other hand, the central position of Reserve Bank in the financial system, and its position as a definitive supplier of liquidity to the framework, provides for it a key part in monetary emergency administration. In satisfying this part, the Reserve Bank will keep on arranging nearly with the Government and with the other Council offices.

The unemployment rate of Australia is falling since 1989. Thus the RBA have decided to determine the reductions in the rate of unemployment and will try to maintain the present trend and also different policies for producing sustainable growth. According to RBA statements the economy is stimulating with the low interest rated and unemployment is struck to around 6.25% (Pascoe, 2014). According to the policy, it is believed that the country, Australia is trying to have high wages, high value added economy and also high productivity. This would help to sustain the lives of people and also take up risks. This would also help to improve infrastructure, human capital accumulation and education (Rba.gov.au, 2015).

It is also to be noted that there in an increase in the unemployment rate since the mid of 2011 which is about 5.75%. To meet the unemployment objectives, a Newstart Allowance have been started. The government is providing funds for various services for assisting the candidates who are looking for various job opportunities. The primary reason for such intervention is to support the unemployed people and reduce the unemployment for providing adequate living standards and also ensure that the people of Australia obtain employment. The allowance structure that is being decided is $501.00 per fortnight for single people, or $452.30 each for a couple (Ncoa.gov.au, n.d.).

Conclusion

In conclusion, it can be inferred that due to rise in the globalization there is a significant rise in competition in the market. Even though the nation, Australia is one of the most developed countries, it is lagging behind due to rising unemployment and inflation rate. The government needs to develop measures that would help to enhance the performance of the economy in terms of exchange rate, growth rate, inflation rate and also unemployment rate. Here the report has well identified the relationship between the inflation rate and the unemployment rate of Australia. Further the report discusses the impact of monetary policy and the intervention of government undertaken to improve the unemployment rate and also inflation rate of Australia.

References

Abel, A. and Bernanke, B. (2001). Macroeconomics. Boston: Addison-Wesley.

Abs.gov.au, (2015). 1345.0 – Key Economic Indicators, 2014. [online] Available at: https://www.abs.gov.au/ausstats/[email protected]/mf/1345.0 [Accessed 29 Jan. 2015].

BBC News, (2014). Australia jobless rate at 2002 high. [online] Available at: https://www.bbc.com/news/world-australia-30426343 [Accessed 29 Jan. 2015].

Creighton, A. (2014). Annual inflation rate dips to 2.3 per cent as power prices fall. [online] TheAustralian. Available at: https://www.theaustralian.com.au/business/economics/annual-inflation-rate-dips-to-23-per-cent-as-power-prices-fall/story-e6frg926-1227098362128?nk=bf7f213fb407e18f438c9675cd72aceb [Accessed 29 Jan. 2015].

Data.worldbank.org, (2015). GDP growth (annual %) | Data | Table. [online] Available at: https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG [Accessed 29 Jan. 2015].

DoÄŸrul, H. and Soytas, U. (2010). Relationship between oil prices, interest rate, and unemployment: Evidence from an emerging market. Energy Economics, 32(6), pp.1523-1528.

Hubbard, R. and O’Brien, A. (2006). Macroeconomics. Upper Saddle River, N.J.: Pearson Prentice Hall.

Inflation and unemployment in economies in transition. (2000). Economic Modelling, 17(3), p.337.

Karahan, Ö. (2012). The Relationship between Inflation and Inflation Uncertainty: Evidence from the Turkish Economy. Procedia Economics and Finance, 1, pp.219-228.

KELLY, G. (2000). Employment and concepts of work in the new global economy. International Labour Review, 139(1), pp.5-32.

Krugman, P. and Wells, R. (2009). Macroeconomics. New York, NY: Worth Publishers.

Langdana, F. (2009). Macroeconomic policy. New York: Springer.

Lanne, M. and Luoto, J. (2013). Does Output Gap, Labour’s Share or Unemployment Rate Drive Inflation?. Oxf Bull Econ Stat, 76(5), pp.715-726.

Lehmann, E. (2011). A Search Model of Unemployment and Inflation*. The Scandinavian Journal of Economics, 114(1), pp.245-266.

Mankiw, N. (2007). Macroeconomics. New York: Worth Publishers.

Ncoa.gov.au, (n.d.). 9.11 Unemployment benefits and the minimum wage. [online] Available at: https://www.ncoa.gov.au/report/appendix-vol-1/9-11-unemployment-benefits-minimum-wage.html [Accessed 29 Jan. 2015].

Pascoe, M. (2014). The government is failing at the limits of monetary policy. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/business/the-government-is-failing-at-the-limits-of-monetary-policy-20140820-1065y5.html [Accessed 29 Jan. 2015].

Qgso.qld.gov.au, (2015). Data Tables: Employment growth and unemployment (a)(b), Queensland and Australia, 1978–79 to 2013–14 (Queensland Government Statistician’s Office, Queensland Treasury and Trade). [online] Available at: https://www.qgso.qld.gov.au/products/tables/employment-growth-unemployment-qld/index.php [Accessed 29 Jan. 2015].

Rateinflation.com, (2015). Australia Historical Inflation Rate – 2002 to 2013. [online] Available at: https://www.rateinflation.com/inflation-rate/australia-historical-inflation-rate?start-year=2002&end-year=2013 [Accessed 29 Jan. 2015].

Rba.gov.au, (2015). RBA: SMP November 2013-Box B: The Increase in the Unemployment          Rate. [online] Available at: https://www.rba.gov.au/publications/smp/2013/nov/html/box-b.html [Accessed 29 Jan. 2015].

ROY, S. (2011). Unemployment Rate and Divorce*. Economic Record, 87, pp.56-79.

Ruge-Murcia, F. (2004). The inflation bias when the central bank targets the natural rate of unemployment. European Economic Review, 48(1), pp.91-107.

Sum, V. (n.d.). Unemployment, Consumer Confidence, Business Confidence, Inflation and Monetary Policy. SSRN Journal

Tradingeconomics.com, (2015). Australia Inflation Rate | 1951-2015 | Data | Chart | Calendar | Forecast. [online] Available at: https://www.tradingeconomics.com/australia/inflation-cpi [Accessed 29 Jan. 2015].

Tradingeconomics.com, (2015). Australia Inflation Rate | 1951-2015 | Data | Chart | Calendar | Forecast. [online] Available at: https://www.tradingeconomics.com/australia/inflation-cpi [Accessed 29 Jan. 2015].

Warne, A. and Vredin, A. (2006). Unemployment and Inflation Regimes. Studies in Nonlinear Dynamics & Econometrics, 10(2).