Possible relationships between unemployment and inflationSyllabus: Discuss, using a short-run Phillips curve diagram, the view that there is a possible trade-off between the unemployment rate and the inflation rate in the short run.
Achieving one Government Macroeconomic Objective can often have an adversr effect on a different objective. For example, a large balance of payments Current Account (BoP - CA) deficit might cause a fall in the exchange rate and thereby impact adversely on the rate of inflation. In the same way there is often thought to be a short term trade-off between unemployment and inflation.
You can see this if you think of Aggregate Demand as
the linking variable. If AD increases (for whatever reason) it will put
downward pressure on unemployment and upward pressure on inflation.
This trade-off was first encapsulated in the Phillips Curve - see
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But then came stagflation! In the late 1960īs and 1970`developed economies began to experience rising inflation and rising unemployment at the same time. With hindsight it was cleary major cost- push inflationary pressures that caused the rising inflation but policy-makers kept decreasing AD and wondered why inflation was unaffected and unemployment kept increasing. Economists were baffled until Milton Friedman (the Monetarist/Free Market economist) burst onto the scene with his critique of the Phillips curve which became known as the 'long-run' or 'expectations-augmented' Phillip's Curve, (explained on the next page - Page