Unemployment and inflation are two intricately linked economic concepts. Over the years there have been a number of economists trying to interpret the relationship between the concepts of inflation and unemployment. There are two possible explanations of this relationship – one in the short term and another in the long term. In the short term there is an inverse correlation between the two. As per this relation, when the unemployment is on the higher side, inflation is on the lower side and the inverse is true as well.
This relationship has presented the regulators with a number of problems. The relationship between unemployment and inflation is also known as the Phillips curve. In the short term the Phillips curve happens to be a declining curve. The Phillips curve in the long term is separate from the Phillips curve in the short term. It has been observed by the economists that in the long run the concepts of unemployment and inflation are not related.
As per the classical view of inflation, inflation is caused by the alterations in the supply of money. When the money supply goes up the price level of various commodities goes up as well. The increase in the level of prices is known as inflation. According to the classical economists there is a natural rate of unemployment, which may also be called the equilibrium level of unemployment in a particular economy. This is known as the long term Phillips curve. The long term Phillips curve is basically vertical as inflation is not meant to have any relationship with unemployment in the long term.
It is therefore assumed that unemployment would stay at a fixed point irrespective of the status of inflation. Generally speaking if the rate of unemployment is lower than natural rate, then the rate of inflation exceeds the limits of expectations and in case the unemployment is higher than what is the permissible limit then the rate of inflation would be lower than the expected levels. The Keynesians have a...
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