Question

1. Explain what is meant by the "wage-price" spiral.

2. Based on the 'early incarnation' of the Phillips curve, explain what effect an increase in the unemployment rate will have on the inflation rate.

3. During which decade did the original Phillips curve break down? Also, briefly explain why the original Phillips curve broke during this period.

4. Based on your understanding of the Phillips curve, explain what happens to actual inflation (relative to expected inflation) when the actual unemployment rate is either above or below the natural rate of unemployment.

5. What is the difference between deflation and disinflation?

How will the crisis affect the natural rate of unemployment

Answer 1

The cyclical process for rise in wage and price is the wage-price spiral. This shows the cost and effect relation between price and wages. There is a strong mutual link between wage growth and inflation. High inflation makes upward pressure in the wages of workers and rise in wage to meet rising prices and also maintain living standard of the people. Powerful trade union, strong economy, low employment level is the factors which influence the price-wage spiral.
Philips curve shows the relation between unemployment and inflation. The original Philips curve shows that the increase in unemployment leads to lower level of inflation. Early incarnation of Philips curve explain the effect of rise in unemployment on inflation rate.
In 1970s several economists find that the trade off between unemployment and inflation is no longer existed. There was a possibility of umber of inflation rates for given level of unemployment. It shows that in long run there is no trade off between unemployment and inflation.
When actual unemployment rate will be less than natural rate of unemployment, the inflation will increase and continue to rise until the unemployment rate return to its natural rate. If actual unemployment rate is less than its natural rate the economy will growing faster than sustainable rate. The upward pressure over the wage rates and prices will lead to higher inflation rate. The natural rate of unemployment is affected by change in democratic features, educational attainment, work experience, public policies and changes in productivity and growth etc.
Deflation is the decrease in general price level, that is fall in inflation below the zero. The deflationary spiral leads to reduction in investment and production facilities. This will leads to higher unemployment and downturn in consumption. Disinflation is the most aggressive condition of deflation. If inflation is slowing but the inflation remain positive. Falling rate of inflation leads to slowing down of growth rate and higher unemployment.
If there is hyper inflation, the difference between actual rate of unemployment and natural rate of unemployment will be increased. The inflation becomes stable only when the actual unemployment equals the natural rate of unemployment. If the unemployment rate is above its natural rate the inflation will decelerate. The rise in AD causes high inflation.