Inflation and unemployment By A VANITHA Inflation v

Inflation and unemployment By A. VANITHA

Inflation v v This is the process by which the price level rises and money loses value. There are two kinds of inflation: a) Demand pull b) Cost push

INFLATION - Introduction v v v Inflation is another important indicator of the economy. Inflation is the continuing rise in the overall price level of an economy. Inflation, in large part, guides government policy. Long-term inflation can be a major problem. Inflation is almost always existent, the price level is constantly rising, but in a sustained economy, the inflation rate is stable. Inflation is the rise in price level and people set the prices, so the inflation is caused by people thinking that raising prices will get them more of the output.

DEFINITION

TYPES OF INFLATION There are two types of inflation. v Demand-pull inflation is inflation initiated by an increase in aggregate demand. v Cost-push, or supply-side, inflation is inflation caused by an increase in costs.

Demand pull inflation v Demand-pull inflation is caused by great demand a scarcity of supply. v Demand pull inflation may be due to : Increase in money supply Increase in government purchases Increase in exports a) b) c)

Cost push Inflation v Unlike in demand-pull inflationary economies, cost-push economies may not have surplus demand. However, certain groups have the ability to force their own prices up, therefore forcing those who buy their products to raise their own prices Cost push inflation may arise because of : a) Increase in money wage rates b) Increase in money prices of raw materials. v

Discussion question v Why is inflation bad?

v v v a) b) Unanticipated inflation is bad because it makes the economy behave like a giant casino. Gains and losses occur because of unpredictable changes in the value of money. If the value of money varies unpredictably over time, the quantity of goods and services that money will buy will also fluctuate unpredictably. Resources are also diverted from productive activities to forecasting inflation. Unanticipated inflation leads to : Redistribution of income, borrowers and lenders Too much or too little lending or borrowing

CPI v v v Consumer Price Index (CPI) is one of the most frequently used statistics for identifying periods of inflation or deflation. Large rises in CPI during a short period of time typically denote periods of inflation. The U. S. Bureau of Labor Statistics measures two kinds of CPI statistics: CPI for urban wage earners and clerical workers (CPIW), The chained CPI for all urban consumers (C-CPI-U). Of the two types of CPI, the C-CPI-U is a better representation of the general public, because it accounts for about 87% of the population. The CPI uses a base year and indexes current year prices based on the base year's values.

Headline Inflation v v v The raw inflation figure as reported through the Consumer Price Index (CPI) that is released monthly by the Bureau of Labor Statistics. Also known as "top-line inflation". The headline figure is not adjusted for seasonality or for the often-volatile elements of food and energy prices. Inflation is usually quoted on an annualized basis. A monthly headline figure of 4% inflation equates to a monthly rate that, if repeated for 12 months, would create 4% inflation for the year. Comparisons of headline inflation are typically made on a year-over-year basis.

Core Inflation v v v While headline inflation tends to get the most attention in the media, core inflation is often considered the more valuable metric to follow. Core inflation removes the CPI components that can exhibit large amounts of volatility month to month, ie those that can have temporary price shocks. Core inflation usually excludes energy and food products. Other methods of calculations include the outliers method. The products that have had the largest price changes are taken out.

Hyper inflation v v v Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Price increases are so out of control that the concept of inflation is meaningless. The most famous example of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion!

Stagflation v v A condition of slow economic growth and relatively high unemployment accompanied by inflation. This happened to a great extent during the 1970 s, when world oil prices rose dramatically, fueling sharp inflation in developed countries. Are we seeing that about to happen in early 2008? At least some central banks have expressed concern over inflation even as the global economy seems to be slowing down.

Unemployment and the labour force v v Labour force or workforce - The number of people employed and self-employed plus those unemployed but ready and able to work. Three factors affect the size of the labour force: Population Migration Labour force participation in economic activity. v

Population v v v Birth rates in most industrial countries fell to replacement levels or lower in the 1980 s. This implies an older workforce and higher old-age dependency rates (the number of retired people as a percentage of the population of working age) in the future. By 2010, 15 -20% of the population in industrial economies will be over 65 years of age. On the other hand, developing countries have young populations with up to 50% under 15 years. This suggests an expanding working-age population with potential problems for housing and job creation. .

Migration v v v In the industrial countries, inflows of foreign workers increased since the late 1980 s and a substantial number of illegal immigrants were granted amnesty in America, France, Italy and Spain. Foreign-born persons account for over 5% of the labour force in America, Germany and France; around 20% in Switzerland Canada; and over 25% in Australia German unification boosted that country's productive potential. Wealthier developing countries, especially oil producers, have large proportions of foreigners in their labour forces. However, large numbers of refugees seeking asylum can have significant adverse effects on income per head.

Participation v v Participation rates (the labour force as a percentage of the total population) generally increased in the 1980 s and 1990 s. Earlier retirement for men, especially in France, Finland the Netherlands, was generally offset by more married women entering the labour force, especially in America, Australia, Britain, New Zealand Scandinavia. Women account for a smaller proportion of the workforce in Muslim countries (20%). But they account for a greater proportion in Africa (up to 50%) where they traditionally work on the land.

The unemployment rate v Usually defined as a percentage of the labour v force (the employed plus the unemployed). There are national variations : Germany excludes the self-employed from the labour force; Belgium produces two rates expressing unemployment as a percentage of both the total and the insured labour force. By changing the definition, the unemployment rate can be moved up or, down by several percentage points.

Types of unemployment v v v Frictional : arises from normal labour turnover, ie people entering and leaving the labour force. Generous unemployment compensation leads to high frictional unemployment. European countries like France fall in this category. Structural : arises due to changes in technology, international competition, etc. Arises due to skill obsolescence or lack of competitiveness. Cyclical : fluctuates with the business cycle. Increases during a recession and falls during an expansion.

Full employment v v v a) b) c) The natural rate of unemployment is that rate at which there is no cyclical unemployment, ie all the unemployment is structural or frictional. Full employment occurs when the unemployment rate equals the natural rate of unemployment. Unemployment rate fluctuates because of : Job search Job rationing Sticky wages

Job rationing is the practice of paying employed people a wage that creates an excess supply of labour, a shortage of jobs and increases the natural rate of unemployment. It arises because of : A) Efficiency wage : The company may pay more to attract and retain talent. B) Insider interest : Insiders would not like outsiders to be paid lower wages. C) Minimum wage : The government may specify minimum wages.

Discussion topic v Unemployment rates in Europe have tended to be higher than in the US. Why is this so?

Phillips curve v v In 1958, a New Zealand economist , A. W. H. Phillips proposed that there was a trade-off between inflation and unemployment. The lower the unemployment rate, the higher was the rate of inflation. Governments simply had to choose the right balance between the two evils. Economies did seem to work like this in the 1950 s and 1960 s, but then the relationship broke down.

NAIRU(Non Accelerating inflation rate of unemployment) v v v Now economists prefer to talk about the NAIRU, the lowest rate of unemployment at which inflation does not accelerate. The lowest rate of unemployment at which the jobs market can be in stable equilibrium. When unemployment is above this rate, demand can potentially be increased to bring it to the natural rate, but attempting to lower it even further will only cause inflation to accelerate.

The Keynesians and the Monetarists v v v v Keynesians, assumed that the economy would always have some slack. The government could lower the rate of unemployment if it was willing to accept a little more inflation. However, economists such as Milton Friedman argued that the economy of left to itself would adjust to full employment. The supposed inflation-for-jobs trade-off was in fact a trap. Governments that tolerated higher inflation in the hope of lowering unemployment would find that joblessness dipped only briefly before returning to its previous level, while inflation would rise and stay high. Instead, they argued, unemployment has an equilibrium or natural rate, determined not by the amount of demand in an economy but by the structure of the labour market. They stressed the importance of flexible labour markets.

Unemployment data

Headline inflation data

Core inflation data

Commodity price data