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In: Economics

Reply to this Discussion Post : W.H. Phillips studied inflation and unemployment during the late 1800’s...

Reply to this Discussion Post :

W.H. Phillips studied inflation and unemployment during the late 1800’s and early 1900’s. He discovered an inverse relationship between the two. What was found was when unemployment was high, wages increased slowly; when unemployment was low, wages rose rapidly(Econlib). Therefore, the lower the unemployment rate is, the tighter the labor markets are. Which causes businesses to raise wages in order to find workers during scarce labor The Phillips curve displays the relationship between unemployment and wage habits during business cycles. This allows economists to estimate the rate of wage inflation that would exist if unemployment lasted for a certain amount of time.
What is the importance of the expectations between inflation and unemployment? The faster workers’ expectations of price inflation adapt to changes in the actual rate of inflation, the more quickly unemployment will return to the natural rate. Which in turn causes the government to be less successful in reducing unemployment through monetary and fiscal policies.
Is the Phillips curve correct? Many famous economists, mainly monetarists such as Edmund Phelps and Milton Friedman want to depict the Phillips theory. The argument is that there is no stable trade-off between unemployment and inflation(Economics Help). That demand policy doesn’t reduce unemployment in the long term.
Overall, the Phillips curve is useful for capturing forecasting information on inflation. However, it may not be the most accurate framework and it may have some faults. In today's economy the Phillips curve may not be as complex to capture all the intricacies in today's complex environment. However, the Phillips curve forecast does outperform some of the other complicated models.



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Expert Solution

               The theory of Phillips Curve states that there exist an inverse and stable relationship between inflation and unemployment. In detail, In order to ensure economic growth the government engages in expansionary fiscal and monetary policy which induces businesses and industries boost up production of goods and services to meet the demand provoked by the government via public spending(such as incentives, subsidies, public welfare schemes) and for which more amount of laborers will be required that in-turn reduces the rate of unemployment and since people get employed and earn, a majority of population comes under the consumer circle or the demand wave which gives rise to inflation that is rise in price caused due to increased demand.

It is highly importance to draw a line between inflation and unemployment because in short run a lower level of unemployment can be achieved by way of higher inflation and thereby in the long-run the economy will stabilize and thus the unemployment level to return to a natural rate due to saturated market at a higher level of inflation. As market gets saturated after a certain level, wage rate falls with a consequent effect on unemployment. In addition, the government’s success rate in reducing unemployment through fiscal and monetary policy tends to become ineffective.

As a response to the question of whether the Phillips curve is correct, in this era of information age economies are determined by a various economic indicators and inflation and unemployment can be balanced not only with fiscal and monetary policies but with various other practices such as technology, international trade and imprint of local workforce in the global economy. It is also true that Phillips curve forecast outperform other models with regard to the level of complexities as Phillips curve states that economies keep on changing their fiscal and monetary policy to adjust unemployment and inflation rather maintain low level of inflation with a mild inflation which is absolutely healthy for an economy to progress.


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