Question

Why do more flexible wages/prices result in inflation being more responsive to deviations from the natural rate of unemployment?

Answer 1

Flexible wages cause the wages to come down when more people are unemployed and supply of labor is higher than the demand of labor. A lower wage translates into the lower price and supply of goods increases. It causes inflation to come down. Though, new job opportunities are created due to increase in production activities. Later on it sets in the demand pull inflation and flexible wages cause the wages to increase. It translates into the increase in price. So, inflation becomes responsive to the unemployment and change in wages of the workers. If there is a change in structural and frictional unemployment, then there is an increase or decrease in the natural rate of unemployment. So, the impact of flexible wages causes the natural unemployment rate to change and it affects inflation. Here, with increase in in the natural rate of unemployment decreases the wage and inflation rate falls and vice versa.