Inflation and Unemployment

Topics: Unemployment, Inflation, Economics Pages: 7 (1604 words) Published: January 20, 2014




Inflation seems to be a chronic problem in many parts of the world today and unemployment, a phenomenon, true for Pakistan, and valid for United States and other western economies. Even the fastest growing Chinese economy is not totally immune to it. Thus this research project deals with the analysis of unemployment and inflation in Pakistan. The purpose of this research is to analyze the relationship that exists between these two macroeconomic variables, which affect every nation as well as an individual.

The Phillips curve shows a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. It is the trade-off between inflation and unemployment (Mankiw, 2002). The lower the unemployment in an economy, the higher the rate of change in wages paid to labor in that economy.

The relationship between unemployment and inflation the two macroeconomic variables is usually summarized by the Phillips curve. Different studies have been conducted related to these variables in order to see whether any relationship between these two macroeconomic variables exists or not. While analyzing the trade-off between inflation and unemployment in Asia, (Dua 1996), takes inflation as the function of expected inflation, unemployment gap/ output gap, exchange rate, import inflation and oil price inflation. In India and Philippines the tradeoff between inflation and unemployment does not exist, whereas, in Japan, Korea, Singapore, and Hong Kong it does. (Rafael, MacCulloch, & Oswald 2000), on the other hand, suggest that welfare and life satisfaction level is a function of inflation and unemployment and people are happier when rates of both are low. However unemployment in comparison with inflation depresses people more than inflation. Thus while controlling country fixed-effects, year effects, and time trends, it is estimated that people will trade 1% increase in unemployment for 1.7% increase in inflation. A strong positive relation between unemployment rate and inflation rate lagged one or two years is also shown, which is inconsistent with both Philips curve and NAIRU. In other words the trade-off between inflation and unemployment rate does not exist, except in the same year, and in the long run unemployment is a positive function with inflation (Niskanen 2002). Namibia, using the time series data from 1991-2005, exhibits the presence of stagflation in its economy. In other words he found increase in both inflation and unemployment at the same time, which contradicts the traditional short-run Philips curve (Ogbokor 2005). (Furuoka 2007) using the data of Malaysia from 1975-2004 shows and existence of co-integrated as well as casual relationship between inflation and unemployment. That is the study provides an empirical evidence to support the Philips curve. Likewise, Philips curve also exists in Japan, with negative coefficients of linear link between inflation and unemployment. Also there is a generalized linear and lagged relationship between labor force, unemployment and inflation in Japan, which is confirmed by the fact that the driving force behind unemployment and inflation is the change rate of labor force level (Kitov 2007). In this paper, a Philips curve with linear link will be calculated for Pakistan to see if the negative relationship between the variables exists or not.

Problem Statement:
What is the likely relationship between inflation and unemployment in Pakistan? Hypothesis:
If unemployment increases, then inflation decreases.
Data Source:
Secondary data for the purpose of this research has been obtained from the year 2000-2011. The data on unemployment rate (percentage of total labor force) and inflation rate (general not adjusted for food and energy) for Pakistan, has been taken from the...
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