According to Bross (2006), the relationship between inflation and unemployment was discovered in 1958 by A. W. Phillips. The simple concept is that, when unemployment decreases, workers strive for higher wages. Employers pass these wages on to consumers in the form of higher prices for their products. The higher prices are the evidence of inflation. This relationship then implies that policy makers can only target low rates of inflation or low unemployment rates but not both.
High rates of unemployment coupled with high rates of inflation were observed in the 1970s (Bross, 2006). This situation was referred to as stagflation. Economists then argued that there existed a natural level of unemployment. Even the slightest decrease in the rate of unemployment levels from this rate would cause an increase in the rate of inflation. At this point then, policy makers were advised to target a natural rate of economy. This rate was however difficult to estimate. It was difficult to obtain economic growth that fostered stability in prices and regardless of the level of unemployment.
Practically pinning down the natural rate of unemployment has been complicated. The problem is that the estimates are both imprecise and changing. Estimates of the natural rate of unemployment for the US changed from 4.4% to 6.2% to 7.2% in the 1960s, 1970s and 1980s respectively (Bross, 2006). The trend changed in the 1990s as inflation remained relatively constant at 3.0% and the rate of unemployment decreased to about 4.6%. In the later years, while economists warned that any decreases in unemployment levels would bring the levels of inflation out of control, the rate of inflation remained relatively calm (Lacker and Weinberg, 2006). This gave the impression that US had reached the Goldilocks state. This is the state where everything is just right.
According to this argument by Phillips, since the two are inversely related, any government that intends to lower the level of unemployment should be willing to embrace high rates of inflation (Lacker and Weinberg, 2006). A government is able to influence both the rates of inflation and unemployment. According to the Federal Reserve, the monetary policy affects the economy-wide demand for goods and services as well as the human resources used to produce them, and inflation. This is done by mainly by its impact on the economic conditions that affect companies and households. If, for example, the federal government raises the federal funds rate, banks and other lending institutions pass the rates to consumers in the form of higher interest rates. Changes in the short-term interest rates impact on long-term interest rates, like rates of residential mortgages, and corporate bonds. This is because short-term rates are a simple way to determine future short-term rates of interest (Lacker and Weinberg, 2006). Changes in long-term rates affects also affects prices of other assets like foreign exchange rates of the dollar and equity prices. When interest rates are lower, the prices of equities surges as investors discount the expected return on equities.
These resultant financial conditions affect economic growth. When interest rates are lower, households and organizations are more willing to borrow and buy goods and expand. Firms react to these changes in total by employing a bigger workforce and increasing production (Lacker and Weinberg, 2006). Consequently, household incomes increase hence increasing the amount of disposable income. The influences of the monetary policy on the economy and employment are not felt immediately and are dependent on various factors which make the task of determining the impact of the monetary policy difficult.
The monetary policy also affects the rate of inflation in various ways. When the federal funds rate is increased, the demand for goods and services increases (Lacker and Weinberg, 2006). This increases influence the cost of production in the form of higher costs of labor, materials required for production and number of employees in the firm. Policy actions also influence the expectations of economic performance in the future.
Case Study of Nigeria
Nigeria has an economic freedom score of 55.1. This makes it the 120th freest economy in the world. The country is ranked 21st of 46 sub-Saharan African countries. It has an overall economic score that is below the world’s average (Lacker and Weinberg, 2006). Recently, the country has seen an economic slowdown owing to a decrease in the labor freedom and a rise in government spending. Most of the reforms that Nigeria has pursued in the past have been centered on improving the efficiency of government regulations and enhancing management of public funding. Nigeria has had a surge in oil production that has led to a sudden economic growth (Omoke, 2010).
Nigeria rebased its GDP from 1990 to 2010, ensuing in an 89% expansion in the evaluated size of the economy. Accordingly, the nation now boasts of having the biggest economy in Africa with an expected ostensible GDP of USD 510 billion, surpassing South Africa’s USD 352 billion. The activity likewise reveals a more differentiated economy than expected some time back (Ezeabasili, Mojekwu and Herbert, 2012). Nigeria has kept up its amazing development over the previous decade with a record assessed 7.4% development of true Gross Domestic Product (GDP) in 2013, up from 6.7% in 2012. This development rate is higher than the West African regional level and far higher than the Sub-Saharan Africa level. The growth of the economy keeps on being underpinned by ideal enhancements in the non-oil segment, with genuine GDP development of 5.4%, 8.3% and 7.8% in 2011, 2012 and 2013, individually. Farming – especially trim generation – exchange and administrations keep on being the primary drivers of non-oil division development. The oil segment development activity was not as amazing with 3.4%, -2.3% and 5.3% assessed development rates in 2011, 2012 and 2013, correspondingly. Development of the oil segment was hampered all through 2013 by supply interruptions emerging from oil burglary, pipeline vandalism and by powerless financing in upstream exercises with no new oil find.
|Real GDP growth||6.7||7.4||7.2||7.1|
|Real GDP per capita growth||3.9||3.6||4.4||4.7|
|Budget balance % GDP||-1.4||-1.8||-1.2||-2|
|Current account balance % GDP||2.8||4.4||5.8||5.1|
Going ahead, there are prospects of solid financial development despite the fact that drawback dangers stay dug in (Lim, 2009). Such prospects are required to rely on proceeded with recuperation of the worldwide economy, positive rural harvests and a conceivable support in vitality supply emerging from the force part change, and additionally on expected positive conclusions from the Agricultural Transformation Agenda. Complete financial and structural changes are likewise anticipated that will enhance monetary development. By and by, the nation’s continuous GDP rebasing may impact the development figures, potentially making them lower going ahead since the expected result is a bigger economy.
Risks to Nigeria’s monetary development are the drowsy recuperation of the worldwide economy, security challenges in the northeastern piece of the nation, ongoing fomentation for asset control in the Niger Delta and conceivable diversion from the progressing changes as a consequence of the approaching 2015 general decisions (Ezeabasili, Mojekwu and Herbert, 2012). Negative development of the oil area might additionally keep on dragging down general development until an enduring result is found to the test of oil robbery and weak financing in investigation because of the unverifiable state of play in the part as a consequence of non-section of the Petroleum Industry Bill.
Nigeria confronts a progressing test of making its decade-since a long time ago supported development more comprehensive. Destitution and unemployment stay noticeable among the real difficulties confronting the economy (Ezeabasili, Mojekwu and Herbert, 2012). One purpose behind this is that the profits of economic development have not sufficiently trickled down to the poor. The national powers are not unaware of this reality. In this way, poverty diminishment, mass occupation creation, and insurance of the most powerless and those in the vast casual division are the center of current strategy dialogue and activities. Actually, the 2014 national plan that has recently been passed into law by the national assembly centers basically on making more employments and making development more comprehensive.
Expanded reconciliation of the poor into worldwide worth chains is fundamental for poverty diminishment. Horticulture, which is to a great extent casual, utilizes around 70% of the work drive, a substantial parcel of which is poor. Increasing the value of agribusiness tradable products will make more employments through its upstream and downstream combination with different parts of the economy, expand send out incomes, help wage of the poor and diminish destitution occurrence.
The AD/AS model is utilized to delineate the Keynesian model of the economic cycle. Developments of the two curves could be utilized to anticipate the impacts that different exogenous events will have on two variables: true GDP and the value level (Elwood, 2010). Moreover, the model might be joined as a part in any of a mixture of element (models of how variables like the value level and others develop about whether). The Ad–as model might be identified with the Phillips curve model of compensation or value growth and unemployment.
Aggregate demand curve
The AD curve is characterized by the IS–LM harmony pay at diverse potential value levels. The Aggregate demand curve AD, which is descending inclining, is inferred from the IS/LM model. It demonstrates the consolidations of the value level and level of the yield at which the products and possessions markets are at the same time in balance (Elwood, 2010). The above figure indicating IS and LM curves, where LM curve moves descending to the right to LM’ and subsequently moving the new harmony to E’ where both products and currency business gets cleared. Presently, the new yield level Y’ relate to the lower value level P’. Subsequently a decrease in value, which is indicated in the figure, prompts an increase in the balance and spending. The real cash supply has a positive impact on total demand, as does true government spending implying that when the free variable alters in one course, total demand alters in the same course); the exogenous part of assessments has a negative impact on it (Federal Reserve, 2014).
Slope of AD curve
The slant of AD curve reflects the degree to which the genuine parities change the balance level of spending, taking both stakes and merchandise markets into attention (Federal Reserve, 2014). An increase in genuine offsets will prompt a bigger build in harmony salary and spending, the more modest the premium responsiveness of cash demand and the higher the premium responsiveness of speculation demand. An increase in true offsets prompts a bigger level of pay and spending, the bigger the estimation of multiplier and the more diminutive the pay reaction of cash demand.
This intimates that: The AD curve is compliment the more modest is the premium responsiveness of the demand for cash and bigger is the premium responsiveness of speculation demand (Forder, 2010). Likewise, the AD curve is compliment; the bigger is the multiplier and the littler the salary responsiveness of the demand for cash.
Impact of economic development on the AD curve
Aggregate demand curve shifts rightward if there should be an occurrence of a money related development. An increase in the ostensible cash stock prompts a higher true cash stock at each one level of costs (Federal Reserve, 2014). In the benefit showcase, the lessening in investment rates instigates general society to hold higher genuine equalizations. It invigorates the total demand and along these lines builds the harmony level of pay and spending. Subsequently, as should be obvious from the chart, the aggregate demand curve shifts rightward in the event of a financial development.
Aggregate demand curve
The aggregate demand curve may reflect either work market disequilibrium or work market balance. In either case, it demonstrates the amount yield is supplied by firms at different potential value levels (Federal Reserve, 2014). The aggregate supply curve (AS curve) portrays at every given cost level, the amount of yield the organizations plan to supply.
The Keynesian aggregate demand curve demonstrates that the AS curve is essentially level intimating that the firm will supply whatever measure of merchandise is demanded at a specific value level amid an economic depression (Federal Reserve, 2014). The thought behind that is on account of there is unemployment, firms can promptly acquire to the extent that as they need at that current pay and creation can build without any extra expenses (e.g. machines are unmoving which can just be turned on). Firms’ normal expenses of creation thusly are expected not to change as their yield level progressions. This gives a reason to Keynesians’ backing for government intercession.
The aggregate yield of an economy can decrease without the value level declining; this, in conjunction with the Keynesian conviction of wages being rigid downwards, clears up the requirement for government boost (Forder, 2010). Since wages can’t promptly change low enough for total supply to movement outward and enhance aggregate yield, the administration must intercede to perform this result. On the other hand, the Keynesian aggregate demand curve additionally contains a typically upward-slanting area where total supply reacts appropriately to changes in value level (Federal Reserve, 2014). The upward incline is because of the theory of unavoidable losses as firms build yield, which expresses that it will get to be imperceptibly more lavish to fulfill the same level of change in beneficial limit as firms develop. It is additionally because of the lack of characteristic assets, the uncommonness of which causes expanded creation to likewise get to be more lavish. The vertical segment of the Keynesian curve compares to the physical furthest reaches of the economy, where it is difficult to expand yield.
Changes of total demand and total supply
The accompanying abridges the exogenous occasions that could move the total supply or aggregate demand curve to the right. Exogenous occasions happening in the inverse bearing would move the pertinent curve in the inverse heading.
Changes in aggregate demand curve
The accompanying exogenous occasions would move the aggregate demand curve to the right. Accordingly, the value level would go up (Elwood, 2010). Furthermore, if the time period of dissection is the short run, so the aggregate demand curve is upward inclining as opposed to vertical, genuine yield would go up; however over the long haul with total supply vertical at full employment, true yield would stay unaltered.
Rightward total demand movements radiating from the IS curve:
Rightward total demand movements exuding from the LM curve:
Changes in aggregate supply curve
The accompanying exogenous occasions would move the short-run aggregate demand curve to the right (Elwood, 2010). Subsequently, the value level would drop and true GDP would expand.
The accompanying occasions would move the long-run aggregate supply curve to the right:
Nigeria’s economy is mainly dependent on its oil reserves. The country had a major shakeup in 2008 when rebel groups held up some oil wells in the country preventing the population from benefiting from them (Oladipo and Akinbobola, 2011). The event caused a drop in the productivity of the country (Olubusoye and Oyaromade, 2008). Majorly, the country could not produce a sufficient amount of oil to send to its consumers. The situation therefore lessened the supplies of the economy hence shifting the aggregate supply curve to the left. The impact was a rise in the rates of unemployment, a drop in the amount of available income and a drop in economic growth.
The situation has improved ever since. The economy of Nigeria has been rising steadily over the years. This can be proved using the various economic factors. First, the rates of inflation have been dropping steadily. Second, the productivity of the country has also been increasing in the form of oil exports (Oladipo and Akinbobola, 2011). Third, the GDP has also been increasing steadily. This is a sign that the larger part of the population is able to make a living under the current economic situation. Fourth, the available amount of disposable incomes has been on the rise.
There have also been areas where the economy has been deteriorating. The rate of unemployment, for example, has been increasing (Federal Reserve, 2014). This is comparable with the concept presented by the Phillips curve which requires the rate of unemployment and the rate of inflation are always inverted. With the low rates of inflation, there are high levels of unemployment.
In conclusion, the rate of unemployment and the rate of inflation are related. According to Phillips, low rates of inflation are often associated with a push by employees for higher wages. This can be blamed on the high demand for human resource, which puts employees at an advantage. When employees have push for higher wages, employers may yield by passing on the costs of production and the higher costs of labor to the consumer. When this happens, employees have a higher amount of disposable income available to them. This enables them to make more purchases. Firms on the other hand are able and find it necessary to make expansions hence similarly making purchases.
policies are often intent on decreasing the rate of unemployment or the rate of
inflation. The case of Nigeria is a good example of this phenomenon. The
government has been intent on maintaining low costs of production. This has
impacted on the economy by decreasing the rates of inflation and increasing the
rates of unemployment. The growth of the economy has mainly been dependent on
the increases in the amount of oil deposit finds and diversity in the sources
Bross, E., 2006. What’s the relationship between inflation and unemployment? | Dollars & Sense. [online] Dollarsandsense.org. Available at: <http://dollarsandsense.org/archives/2006/0906drdollar.html> [Accessed 24 Aug. 2014].
Elwood, S., 2010. Retiring the Short-Run Aggregate Supply Curve. The Journal of Economic Education, 41(3), pp.314–325.
Ezeabasili, V., Mojekwu, J. and Herbert, W., 2012. An Empirical Analysis of Fiscal Deficits and Inflation in Nigeria. International Business and Management, 4(1), pp.105–120.
Federal Reserve, 2014. FRB: How does monetary policy influence inflation and employment?. [online] Federalreserve.gov. Available at: <http://www.federalreserve.gov/faqs/money_12856.htm> [Accessed 24 Aug. 2014].
Forder, J., 2010. The L-shaped aggregate supply curve and the future of macroeconomics. Department of Economics (University of Oxford).
Lacker, J. and Weinberg, J., 2006. Inflation and Unemployment. Federal Reserve Bank of Richmond, Annual Report.
Oladipo, S. and Akinbobola, T., 2011. Budget deficit and inflation in Nigeria: a causal relationship. Journal of Emerging Trends in Economics and Management Sciences, 2(1), pp.1–8.
Olubusoye, O. and Oyaromade, R., 2008. Modelling the inflation process in Nigeria.
Omoke, P., 2010. Inflation and Economic Growth in Nigeria. Journal of Sustainable Development, 3(2), p.159.
Lim, G., 2009. Inflation Targeting. Australian Economic Review, [online] 42(1), pp.110-118. Available at: <http://dx.doi.org/10.1111/j.1467-8462.2009.00537.x> [Accessed 24 Aug. 2014].
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