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That means when unemployment is high, price level keeps low and when inflation goes high, unemployment takes a down turn. The problem with this phenomenon is that the government and the…
In long-term, Phillips curve shows a lot of significant differences. Economists have noted that in long run, inflation and unemployment becomes increasingly unrelated to each other. That means a change in the unemployment seems to have little or no effect on the inflation and vice versa.
Inflation is also inversely proportional to the total consumer spending. As inflation goes up consumers are wary of spending and hold their purchases as dearly as possible. This is due to the fact that when prices rise there is also a hike in the expected price levels in the future that has an adverse effect on the consumer spending. When prices increase the consumer spending power comes down and disposable incomes are significantly lower.
When unemployment is low and there is an increase in price level, wages will rise in response to higher prices. This is because in low unemployment situation, employees can successfully demand full compensation for the higher prices. This has spiralling effect on both the wages and general input costs along with the rate of inflation. All these factors tend to leapfrog each other under low unemployment.
When unemployment is moderate, however, the employees will not be compensated in full and will have to settle for less, and so the wage costs do not rise as fast as prices when unemployment is high. This will stop the rise of the prices and rate of increase in inflation.
Economists note that in developed economies such as Australia, the tendency of the rate of unemployment automatically has a tendency to reach the NAIRU rate of employment. Whenever there is inflationary pressure, the unemployment in the long term adjusts itself towards NAIRU rendering the short term Phillips curve invalid.
The below figure shows that “an extra one percentage point of unemployment pushes the inflation rate down by about 0.4 percentage points in the following year--more in some ...
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