Macroeconomic Analysis of Unemployment and Inflation Report

This report provides a comprehensive macroeconomic analysis of the relationship between unemployment and inflation, focusing on the Phillips curve theory. It begins with a review of theoretical literature, discussing arguments both supporting and challenging the curve, including the works of Phillips, Friedman, and Phelps. The report then presents a theoretical framework, illustrating the short-run and long-run Phillips curves. The core of the report is an examination of empirical literature, with a detailed table summarizing various studies that have investigated the Phillips curve across different economies. These studies employ diverse methodologies and explore various variables to assess the stability and relevance of the Phillips curve in forecasting inflation and understanding economic dynamics. The report concludes by synthesizing these findings, offering insights into the complex interplay between unemployment and inflation and the implications for economic policy.

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

1MACROECONOMICS
Table of Contents
Theoretical Literature.................................................................................................................2
Theoretical framework of Phillips curve....................................................................................5
Empirical Literature...................................................................................................................7
References................................................................................................................................23

2MACROECONOMICS
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

3MACROECONOMICS
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

4MACROECONOMICS
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.

5MACROECONOMICS
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 (%)

6MACROECONOMICS
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

7MACROECONOMICS
Empirical Literature
1. Supporting the Phillips curve theory:

8MACROECONOMICS
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.

9MACROECONOMICS
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.

10MACROECONOMICS
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.

11MACROECONOMICS
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.