The Interrelation Between Inflation And Unemployment

Over the short few centuries since most of the earth’s countries have been developed, national economies have been plagued by various problems.

From war to famine, depression to over inflation, power-hungry dictators to republics with sparring citizens, economists have observed and analyzed what affects national financial stability and how to stimulate or contain market health. For decades, a line has been drawn between utilization of resources and how quickly those resources are progressed from planning to development to disbursement and consumption. A prominent British economist named William Phillips examined how employment and inflation in the United Kingdom and determined that they have an inverse relationship (Phillips, 1958). A careful review of the connection between inflation and unemployment implores economists to reconsider exactly how they are linked and how to determine fiscal and monetary policy regarding the two.

For over one hundred and fifty years, a correlation between unemployment and inflation has been drawn. As A. W. Phillips observed in the United Kingdom for the majority of 1861 through 1957, as employment went down, so did the rate of inflation (Phillips, 1958). Until the 1970s, A. W. Phillips projected a degree of regularity between inflation and unemployment that could have been used to determine policy from. Juan Pablo Nicolini, Terry J. Fitzgerald and Brian Holtemeyer assert that in the last forty years, “there may be a statistical correlation—but not a causal link—between inflation and unemployment.” Interestingly enough, they also found that analyzing the data on a regional level as opposed to national alludes to the stability of the Phillips curve (Fitzgerald, Holtemeyer & Nicolini, 2013).

As Youtube content creator ageonjon describes in his video, The short run tradeoff between inflation and unemployment, unemployment and inflation are unrelated in the long run. Inflation relies predominantly on development in the money supply. Unemployment in the long run is comprised of multiple other factors with nothing in common to inflation, including minimum wage, union power, and the process of finding a job (ageconjon, 2015). When analyzing the relation between employment and inflation in the short-run versus the long-run, Milton Friedman asserts that there is only a tradeoff in the short-run (Friedman, 1968).

Currently, the United States unemployment rate is the lowest it has been in fifty years at 3.5%.

This has been following a steady decline for the past nine years. Between 1999 and 2008, unemployment ebbed and flowed from 3.9% and 6.3% According to the Bureau of Labor Statistics, the unemployment rate rose dramatically to 10%, the highest it had been in twenty-six years, from February 2008 to October 2009. This peak is relative to the housing bubble crash in 2007 (Dept. of Labor, 2019). Although some would proclaim that President Trump has lowered unemployment to its lowest in decades, it has followed its downward trend since shortly after Barack Obama took office in 2008.

Within the last twenty years inflation rates have peaked and troughed from as low as -2.10 percent to as high as 5.6%. The stark contrast in rates came after the market crash in 2007, with the highest rate in twenty years in 2008 falling to the lowest just twelve months later. (Trading Economics, 2019). Aside from two small declines in 2001 and 2006, inflation has been steady between 2.1% and 4.3%. This steady rate has come from attempts to satisfy the dual mandate set for the Federal Reserve: maximize employment and stabilize inflation (Fitzgerald, Holtemeyer & Nicolini, 2013).

After analyzing the data for the last year and creating my own chart, plotting unemployment levels on the x axis and inflation rates on the y axis, it does not seem like the current information confirms the short-run Phillips curve. Aside from a dip in inflation in January of this year, inflation and unemployment have been grouped tightly between 1.5% to 2.5% and 3.5% to 4% respectively (Trading Economics, 2019; Dept. of Labor, 2019). It appears the unemployment rate has been reduced and stable while inflation is being closely monitored to follow suit. At the current time, these levels would contrast with the proclamation that when inflation is high, unemployment is low or vice-versa. Without any drastic downturns in the economy, the unemployment rate should stay relatively constant and the Federal Reserve, attempting to spur growth, will try to slowly increase inflation. This would affirm the short-run Phillips curve, but only as a product of reactionary monetary policy.

While there are correlations between unemployment and inflation in the last twenty years, they do not follow the short-run Phillips curve enough to merit any policies being introduced because of them. In October of 2009 the inflation rate was in the negative and unemployment reached a high of ten percent. However, in January of 2012 inflation was nearly three percent while unemployment was at 8.3% (Trading Economics, 2019; Dept. of Labor, 2019). There are periods of time within the last twenty years that confirm the short-run Phillips curve, but they are inconsistent

The applicability with which the short-run Phillips curve can be used depends on the timeframe of the examined period. Within two years may be short enough to deduce that the Phillips curve is an accurate depiction of unemployment versus inflation. However, as data from the Department of Labor asserts, between 2009 and 2019 is not an ideal time to utilize the short-run Phillips curve in affecting policy. This is largely due to the financial crash and the following recovery, which essentially flipped the curve upside down (Williamson, 2015). The dual mandate bestowed upon the Federal Reserve in 1977 seeks to ensure that the inflation rate is stabilized, and unemployment is consistently low. Due to attempts to regulate both factors in the Phillips curve, leaders of the central bank have involuntarily reduced its long-term accuracy.

Considering the long-run Phillips curve has been essentially rendered obsolete, it may be a moot point to consider it in resolving today’s issue of unemployment and inflation. The Fed may alter policy regarding the two, but the data historically suggests that benefits will only be observable in the short-run. Summarizing a prominent essay from 1972 by Robert Lucas, Fitzgerald, Holtemeyer, and Nicolini proclaim “If a central bank changes its policy, therefore, firms and households may well adjust their economic behavior, thereby disrupting observed past relationships in the data (and possibly rendering ineffective the newly implemented policy).” (Fitzgerald, Holtemeyer & Nicolini, 2013). In observing that the Phillips curve has been largely inconsistent for the past four decades, the belief that the Federal Reserve should look to other factors such as “regional dispersion of economic activity” when determining monetary policy (Murphy, 2019). This suggests that compiling data of market conditions from various regions within the country will be more beneficial to correcting the current climate than simply seeking solutions from typical or adjusted Phillips curves.

If the Phillips curve was stable, and the market fluctuated evenly, unemployment should stabilize within tenths of a percent over a year, which seems likely given the current trend, and inflation should steadily rise. To avoid widespread problems, insane costs of goods, uneven standard/cost of living etc., inflation needs to rise steadily and relatively slowly. Affecting inflation by policy could lead to disaster considering the glass-thin political climate in America; the president stands to benefit handsomely from a prosperous economy so he will try to influence it any way he can.

The current unemployment rate is phenomenal and should remain stable, if not drop closer to zero percent. There are few reasons why all resources within a region should not be utilized to benefit the country and, consequently, the global economy. The object of any policy change at this time should be inflation, with regards to maintaining a stable employment rate. At the most basic level, this requires the average tax paying citizen to spend more than average. Without any wage increase, which should not be government mandated in a predominantly capitalist economy, a rise in spending will be hard-pressed to occur. What the federal government can do, however, is adjust the tax rates and brackets that citizens fall under to influence market habits. Doing so in attempts to catalyze spending will either enable tax payers stimulate the economy by increased spending or investing. Regarding income, the bulk of American citizens are either middle or low class. Should the central bank implement a policy that deposits more money into their bank accounts, those people will be inclined to either spend, invest, or at worst, save it. If they choose to save, the economic climate will not immediately change. However, while the stimulus package of 2009 directly inserted funds into the hands of middle-class citizens, most refrained from depositing it back into the economy (Amadeo, 2019). They did so due to a reluctance to relinquish money. At this time, most people have a skeptical confidence at the least towards our economy and will more than likely attempt to bolster a return from their investing or spending. To offset the reallocated funds from the middle class receiving more money, the ridiculously wealthy one percent could stand to be taxed slightly more heavily.

Throughout the last few decades, economists have had differing opinions on how inflation and unemployment affect each other or whether they do at all in the long-run. Some have suggested an inverse relationship exists. However, they have appeared to be like magnets, but where one was being rotated every so often. For some cycles inflation and unemployment have been getting closer and for others, farther apart. Both have appeared to stabilize and are gradually gravitating towards each other. The unemployment rate is at an impressive low, but inflation is also relatively low compared to the last few years. A stagnant and low inflation is not a sign of a healthy economy. While we still face problems concerning inflation in the United States, considering policy based on their relation to each other does not seem wise.