Macroeconomics - Relation Between Wage Rate and Unemployment Rate

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Running Head: MACROECONOMICS
MACROECONOMICS
Name of the Student
Name of the University
Author Note

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Table of Contents
Theoretical Literature.................................................................................................................2
Theoretical framework of Phillips curve....................................................................................5
Empirical Literature...................................................................................................................7
References................................................................................................................................23

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Theoretical Literature
 Literature in support of Phillips curve theory
According to the author Jean Fares, there is a negative relation between the
unemployment rate and rate of variation in wages, conditions on lagged price inflation. The
author has argued that, Phillips curve theory helps in describing the behaviour of wages in
Canada. This paper arguments that, change in wage rate and unemployment rate have a long-
run relationships. The study have identified how the growth in productivity and its supply
will affect the inflation of the consumers. It was observed that, a small variation in wage rate
will cause a movement in the unemployment rate in the short-run. Wage dynamic affects the
inflation rate of the consumer price (Fares and Jean 2002). These changes in wage rate and
unemployment rate were found in various region of Canada.
Strengths – The strength of this literature is that, it provides information in behaviour
of wages which helps in identifying the living standards of the society. It helps in showing
the value of wages that has been adjusted for inflation.
Lacking/weakness in the literature
The study avoids the microeconomic factors that can cause variations in the result.
The result on micro evidence did not support the study properly. It was suggested that, wage
dynamics is usually described in standard wage. But, the wage behaviour of Canada is not
clearly described through Phillips curve and wage curve model (Button and Kenneth John
2017). The negative relations of change in wage rate and unemployment rate is only reflected
on short-term basis, the study avoids the change in rate in long-run equilibrium rate. Even,
change in growth rate of productivity also plays a vital role in changing the shift of the curve.
The theoretical findings avoided this hypothesis to understand the relationship of

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unemployment rate and change in wage rate. Change in wage rate in long-run equilibrium is
not properly explained by wage curve model.
Practical Implications- from the above findings of negative correlation between wages
& unemployment, it can be help to control the inflation by trading a lower of inflation with
lower level of unemployment. It can provide guidelines to the higher authorities on how to
tolerate the inflation with a given unemployment rate.
 Literature against Philips curve theory
According to the economists, Milton Friedman and Edmund Phelps argued the
concept of Philips curve theory. The economists considers an argument that, Phillips curve
theory doesnot show any trade-off of inflation rate and unemployment rate in long-run. The
economists see an increase in the inflationary pressure in the economy due to increase
demand of increasing the Gross Domestic Product. In case of lower unemployment rate, the
workers are willing to demand higher wage for their work. This cause inflation in wage rate.
Hence, companies increases their price on good and products due to increase of the demand.
They viewed this situation results in unemployment but increases the inflation rate of the
economy. The author also argued that, government cannot trade higher wages to lower the
unemployment in the economy (Brunner, Karl and Allan Meltzer 1976). They also argued
that, Phillips curve is only appropriate in short-run basis. It cannot be applied in long-run.
The inverse relation of unemployment rate and inflation rate doesnot not exists in this case.
They found that, in long-run equilibrium Phillips curve seen as a vertical line, and the
inflation rate has no effect on the employment rate.
Strengths- The strengths of this literature is that, the workers can adapt themselves to
their expected inflation rates on the basis of unemployment rate & inflation.
Lacking/weakness in the literature

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The study mainly focused on the demand and supply side of the economy. It did not
clearly explained the concept of unemployment in the long-term. Economist did not
considered a sustainable economic growth for explaining the literature (Gordon and Robert
2018). It has also ignored the policies required to control the cost of the inflation for reducing
unemployment. If these criteria have been properly met, then the goal of reducing
unemployment can be easier.
Practical Implications- when inflation doesnot affect the employment, then this can
help the officials to compensate their current inflation with expected inflation by increasing
compensation for the workers without affecting any unemployment rate causing it to move at
a natural rate.

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Theoretical framework of Phillips curve
The economic concept of Phillips curve shows an opposite relation between inflation
and unemployment. According to this theory, growth in economy leads to inflation, which in
turn create more jobs and less unemployment.
Unemployment rate %
Figure 1: (Phillips curve)
Source: Created by the Author
It can be seen that, there is an inverse relation between inflation and unemployment. If
the unemployment is high, then the inflation is low & and unemployment is low, then
inflation rate falls. This curve originated when the growth in money wage is compared with
unemployment rate. It was found that, there in inverse relation between unemployment and
money wages. Usually, when there is high inflation rate, the unemployment rate is relatively
lower and vice-versa (Hideyuki et al. 2015). This means, when economy is strong, there is
high inflation and lower unemployment and when economy is weak, the unemployment is
higher and inflation is lower. This is a short-run Phillips curve. Whereas, in long run, there is
a natural rate of unemployment.
Unemployment Rate (%)
Inflation
Rate (%)

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Figure 2: (Long run and short run Phillips curve)
Source: Created by the Author
The short-run curve shows that, there is a trade-off between inflation rate and
unemployment in short-term. But, in contrast of the long-run Phillips curve, it shows that the
unemployment rate is constant regardless of the inflation rate.
Many of the central banks and policy makers use Phillips curve to tolerate the
inflation and reduce unemployment. They focus on how to give more importance to reduce
the unemployment. It is noticed that, any increase in the fiscal factors will simultaneously
increase the aggregate demand of the economy (Ogbokor and Cyril A 2005). Increase in
labour demand will increase the employment. The companies increases the wages of the
labour. Therefore, workers and labours increase their expectations from higher inflation rates.
Unemployment rate (%)
Inflation
rate (%)
LRPC
SRPC

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Empirical Literature
1. Supporting the Phillips curve theory:

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No. Author/s Objective of
the research
Dependent
Variables
Independent
Variables
Methodology of
analysis used
Specification
of the model
Result &
Recommendations
1. Ball,
Laurence
and
Sandeep
Mazumder
To find the core
inflation in
European region
using Phillips
curve
Core Inflation Expected
Inflation and
level of slack in
economy
Primary data
collection
through survey.
It is a parametric
method, the core
inflation is
assumed to be
determined by
inflation
expected and
level of slack in
the economy.
Basic Phillip
curve model
The great recession in
Europe is due to
movement in core
inflation that has been
raised due to
unexpected economy
& slack in the
economy due to
unemployment.

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2. Ravenna,
Federico
and carl E.
Walsh
To incorporate a
theory of
unemployment
into new theory
known as
Keynesian
theory of
inflation and test
its dynamics
with inflation.
technologies,
unemployed
workers, labour
market
variables
Elasticity of
Inflation.
Primary method,
through
observation. It is
a parametric
observation by
assuming the
study with a
production
function,
assuming the
risks (Ravenna,
Federico, and
Carl E. Walsh.
2008) in
consumption is
fully pooled.
The model
economy,
search friction
model.
The Phillips curve
indicates a quasi-
difference among the
inflate rate and
current & future
values of
unemployment.
Philips curve is
consistent and can fit
with Keynesian
model.

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3. Tang, Chor
Foon and
Hooi Lean
To identify the
stability of
Phillips curve in
Malaysian
economy (Tang,
Chor Foon, and
Hooi Lean
2007).
Inflation Rate Unemployment
rates in
Malaysia
Primary data
through
sampling of
annual data of
economy from
1970-2005 and
KPSS test of the
variables and it
is a parametric
test that uses
null hypothesis
of no
cointegration
relation between
the variables.
Inflationary
and
unemployment
behaviour
model
The Philips curve is
stable in Malaysia
both for the long-run
and short-run trade-
off. Hence, there is a
stable relation
between inflation rate
and unemployment
rate in Malaysia.

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4. Peter
Flaschel,
Goran
Kauermann
and Willi
Semmler
To test price and
wages of
Phillips curve of
United States
(Flaschel et al.
2007)
Wage price Wage growth Observation
using non-
parametric
estimation using
statistics
Multimod
mark III
Wages are always
more flexible than
price with respect to
pressure of demand.
The inflation price
responds more to this
pressure, than wage
inflation.
5. Ho, Sin-Yu
and Bernard
To identify
importance of
Phillips curve in
forecasting
inflation
Inflation Unemployment
rate
Secondary,
comparison of
last 15 years
inflation (Ho,
Sin-Yu and
Bernard Njindan
NAIRU model The inflation of last
four quarters can be
identified using
NAIRU model.

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Iyke 2019).
6. Ramos,
Manuel and
Alberto
Torres
Importance of
Phillips curve to
understand
inflation
dynamics of
Mexico
Inflation Economic
activity
Secondary data
through
historical
analysis from
1992-2006.
GG and GGL
model
Short-run dynamics
of inflation can be
understood by this
technique.
7. Ann-
Charlotte
Non-linearity of
Phillips curve in
US, Australia &
Sweden
Inflation employment Observations,
parametric
method that
assumes, Phillips
curve is liner
(Eliasson and
Ann-Charlotte
2001)
Dynamic,
econometric
model
It is linear for United
States, for rest other it
is non-linear.

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8. Arabinda
Basistha
Importance of
Phillips curve to
measure output
gap.
Inflation Output gap Survey of the
Michigan
consumers
(Basistha,
Arabinda and
Charles R.
Nelson 2001).
Phillips curve The output hap is
large.
9. Bradley
Speigner
To find the
Effect of
Phillips curve in
long-term
unemployment
(Speigner and
Bradley 2008)
Long-term
unemployment
Inflation Labour force
survey using
non-parametric
method of
survey.
Linear model No effect of long-
term unemployment
that is assumed in
Philips curve theory.
10. Banco de
Mexico
To identify
inflation
Inflation Marginal cost
& lagged
Secondary study
using literature
GG and GGL Phillips curve helps
in proper

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dynamics of
Mexico
inflation identification of
inflation in Mexico

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Against the Phillips curve theory
No. Author/s Objective Dependent
Variables
Independent
Variables
Methodology
of analysis
used
Specification
of the model
Result &
Recommendations
1. Stock, James
H and Mark
W. Watson
To forecast the
inflation of the
Phillips curve
in the United
States.
Consumer
inflation,
economy
inflation and
core inflation
(Stock, James
and Mark
Watson 2008)
civilian
unemployment
rate
Primary
method
through survey
of the
literature,
ADL-u model.
Prototypical
Inflation
Forecasting
models
If the employment
rate is close to
NAIRU (a theoretical
level for
unemployment,
below the level
inflation rate is
expected to rise), then
it will help to forecast
the inflation. The
economic activity

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plays a little role in
forecasting the
inflation. If the
unemployment is far
then then only the
information will be
useful to forecast the
inflation. Further
work is needed for
clear observations.
2. Kustepeli
Yesim
To analyse the
Phillips curve
of Turkish
economy and to
Efficient
Labour market
Rate of
inflation
Observation of
annual data
from the
period of
Keynesian
Phillips curve
models.
There is no evidence
of Phillips curve in
the economy. It has
been argued that, only

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determine
whether the
inflation
forecast and
implications of
policy of
Turkey can be
determine using
Phillips curve.
1980-2201. It
is a non-
parametric
(Kuştepeli,
Yesim 2005)
method that
uses statistical
method for
study.
quarterly & monthly
data can be used for
Phillips curve
analysis and monthly
observation of
inflation rate and
unemployment is not
constant because
workers reach new
wage agreements in
every month.
3. Bill Russell
and Anindya
Banerjee
To identify the
positive
between the
unemployment
Inflation Expected
inflation and
conditions on
information
Primary data
collection
through
observations.
New
Keynesian
Phillips curve
models,
There is a small
positive slope found
in the Phillips curve.
An increase of 5

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and inflation available
(Russell, Bill
and Anindya
Banerjee 2008).
It is a
parametric
method that
uses the
hypothesis that
the sum of the
coefficients is
equal to one.
Freidman-
Phelps model,
Hybrid Phillips
curve model
percent of inflation
rate leads to an
increase in the
increase of 1 and half
percentage of
employment rate in
the long-run.
Movements is due to
economic, political
and social sense.
4. Thomas I.
Palley
To understand
the Phillips
curve for
Keynesians
Unemployment
rate
nominal
demand and
nominal wage
deflation
Secondary
research of
Keynesian
economy.
Static model of
unemployment
and sectoral
demand
The unemployment
sectors fully doesnot
depend on the
inflation rate. It has
shown that with an

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increasing rate of
unemployment there
is no effect on the
inflation. This
contrasts the Phillips
curve theory.
5. Marika
Karanassou,
Hector Sala
and Dennis
J.Snower
To overview
the case on
inflation and
unemployment
in long-run of
European
Union.
Europe Union
unemployment
rate
Money growth Observations
of annual data
of variables. It
is parametric
method that
assumes that,
economic
agent make
demand &
The real
money balance
channel, real
wage channel,
dynamic panel
data model.
The trade-off of
Phillips curve has a
far relationship in
long-run. A 10 per
cent increase of
money growth is
associated with only
3.18 fall in EU
unemployment rate.

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supply
decisions on
real variables
(Karanassou et
al. 2003).
6. Frederic
Reynes
To understand
theoretical
concept of
Phillips curve
Labour
Productivity
Real wage Secondary
method
through
literature
review
Wage
bargaining
model
Phillips curve is more
preferred to wage
setting curve. This
contradicts the
phillips curve theory.
7. Ormerod,
Paul,
Rosewell,
Peter
To understand
instability of
Philips curve
Inflation unemployment Observations
using non-
parametric
method of
statistical
Economic
model
Inflation and
unemployment
relationship shifts on
timely basis.

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analysis
(Ormerod et al.
2013)
8. Fabio
Rumler
To compare
New Keynesian
Phillips curve
with time series
model (Rumler,
Fabio, and
Maria Teresa
2010)
HICP inflation Demand &
supply stocks
28
observations
for
comparisons
using
parametric
method of
hypothesis that
labours are
assumed to
enter
production
function.
Time series
model
Phillips curve is not
consistent with time
series model.

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9. James and
Gregor
To identify the
problems of
Phillips curve
Inflation rate demand Survey of US
and UK. Non-
parametric
using
statistical
method
(Nason, James
and Gregor
Smith 2008)
GMM model Keynesian Phillips
Curve cannot be
identified by GMM
model.
10 Douglas
Laxton,
David and
Demosthenes
To identify
problems in
Phillips curve
(Laxton et al.
1999)
Inflation Unemployment
gap
Michigan
survey using
non-parametric
statistical
method
NAIRU Convexity cannot be
identified in case of
large boom in
policies.

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References
Atkeson, Andrew, and Lee E. Ohanian. "Are Phillips curves useful for forecasting
inflation?." Federal Reserve bank of Minneapolis quarterly review 25, no. 1 (2001): 2-11.
Ball, Laurence M., and Sandeep Mazumder. A Phillips curve for the euro area. No. w26450.
National Bureau of Economic Research, 2019.
Basistha, Arabinda, and Charles R. Nelson. "New measures of the output gap based on the
forward-looking new Keynesian Phillips curve." Journal of Monetary Economics 54, no. 2
(2007): 498-511.
Brunner, Karl, and Allan H. Meltzer. "The Phillips Curve." In Carnegie-Rochester
Conference Series on Public Policy, vol. 1, no. 1, pp. 1-18. Elsevier, 1976.
Button, Kenneth John. "Journal of the History of Economic Thought Preprints-AJ
Brown,'Phillips’ Curve', and Economic Networks in the 1950s." (2017).
Eliasson, Ann-Charlotte. Is the short-run Phillips curve nonlinear? Empirical evidence for
Australia, Sweden and the United States. No. 124. Sveriges Riksbank Working Paper Series,
2001.
Farès, Jean. Does micro evidence support the Wage Phillips curve in Canada?. Bank of
Canada, 2002.
Flaschel, Peter, Göran Kauermann, and Willi Semmler. "Testing wage and price Phillips
curves for the United States." Metroeconomica 58, no. 4 (2007): 550-581.
Gordon, Robert J. "Friedman and Phelps on the Phillips curve viewed from a half century's
perspective." Review of Keynesian Economics 6, no. 4 (2018): 425-436.

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Macroeconomics: Growth, Fluctuations, Unemployment, Inequality and Policies. World
Scientific, 2015.
Ho, Sin-Yu, and Bernard Njindan Iyke. "Unemployment and Inflation: Evidence of a
Nonlinear Phillips Curve in the Eurozone." The Journal of Developing Areas 53, no. 4
(2019).
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the NAIRU exist?." (2003).
Kuştepeli, Yeşim. "A comprehensive short-run analysis of a (possible) Turkish Phillips
curve." Applied Economics 37, no. 5 (2005): 581-591.
Laxton, Douglas, David Rose, and Demosthenes Tambakis. "The US Phillips curve: The case
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curve." Journal of Applied Econometrics 23, no. 5 (2008): 525-551.
Ogbokor, Cyril A. "The applicability of the short-run Phillips Curve to Namibia." (2005).
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Ramos-Francia, Manuel, and Alberto Torres. "Inflation dynamics in Mexico: a
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curve." European Economic Review 52, no. 8 (2008): 1494-1521.

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Curve with time series models to forecast inflation." The North American Journal of
Economics and Finance 21, no. 2 (2010): 126-144.
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inflation." Journal of Macroeconomics 30, no. 4 (2008): 1792-1815.
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Tang, Chor Foon, and Hooi Hooi Lean. "Is the Phillips curve stable for Malaysia? New
empirical evidence." Malaysian Journal of Economic Studies 44, no. 2 (2007): 95-105.