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The Short-Run and Long-Run Relationship between Unemployment and Inflation
Matthew Vallejo
University of Arizona Global Campus
ECO 203: Principles of Macroeconomics
Professor Armstrong
October 3, 2022
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The Short-Run and Long-Run Relationship between Unemployment and Inflation
Unemployment and inflation are two of the most important macroeconomic tools that
economists use to determine the health of the U.S economy. It is the federal government’s duty
to keep unemployment and inflation low to keep the economy running smoothly. However, this
happens when everything is working as intended under normal circumstances. Under other
circumstances, when the tune of things changes, it becomes impossible to deal with the issues
following the shift in the graph, bringing unfavorable situations into perspective. Such a
paradigm shift tends to cause a weakness in the economy, which requires the development of
theoretical approaches to explore to enhance a correctional notion. The study of the Philips curve
in the short and long-run outlooks explores how effective policies can promote effective ways of
dealing with inflation and employment in the US, looking at the past and present mechanisms on
the issue. In this paper, I will discuss the historical relationship between inflation and
unemployment, analyze the differences between the short-run and long-run inflation and
unemployment data, analyze the recent 20-year period to see if the trends hold true, and provide
recommendations for fiscal and monetary policy to manage unemployment and inflation.
Historical Relationship
Philips mapped out the relationship between inflation and unemployment in his curve
models. In his demonstration, he brought out the idea of an inverse relationship between the two
variables. This then alludes to the fact that an increase in inflation causes the unemployment
situation to drop significantly (Fitzgerald et al., 2020). In an inverse relationship, the opposite
also holds. This means that having more people working increases their capacity and willingness
to spend what they have earned. In effect, it causes a surge in product demand, followed by an
inflation story. The cycle continues when there are measures to control the aspects every time.
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The relationship has continued to exist when all other factors are kept constant. This explains the
situation in many economies today, although it does not adequately account for all inflation and
unemployment cases. Other controlling factors in the current world economies do not adhere to
the provisions of the Philips ideology.
Many economies believe the Philips curve is instrumental in studying unemployment and
inflation concepts. Ideally, the two are critical components of economic performance (Fitzgerald
et al., 2020). This is because, as a model, it has some solid foundation in its depiction of the
concepts. Equally, it has the desirable empirical support to guide its development of a good
grounding on ideal aspects governing the economic outlook. The Federal Reserve may find this
critical in presenting some key issues, albeit not entirely. Given the inverse relationship between
inflation and unemployment, studying their divergence from the historical perspective helps
understand their manifestation. The study of the historical relationship between the concepts
gives a clear roadmap on how it is likely to change over time. This is because history never lies
and will provide an accurate picture of how the Philips curve will likely turn out in the coming
days. This remains critical in harnessing ideas that would adequately explain the changes
accruing concerning the shift in policy alignments to deal with inflation and unemployment as
key economic concepts.
Short-Run and Long-Run
The Philips curve shows the relationship between inflation and unemployment concepts
in the short run. The diagram below (Fig. 1.0) depicts the Philips curve in the short run. In the
short run, it is evident from the graph that a continued increase in the unemployment rate leads to
a significant decrease in inflation. Under those circumstances, a reduction in unemployment
leads to inflation. The study of the short-run manifestation of the curve highlights the underlying
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issues of concern in the wake of new economic worries over time. In the short run remains ideal
to understand how the economic model shifts its allegiance toward the supposed ideologies.
Fig. 1.0: Adopted from (Gordon, 2018).
In macroeconomic analysis, the short-run alludes to the period when wages and other
prices are sticky (Gordon, 2018). The long run refers to the period where wages, price flexibility,
and market adjustment are achieved (Gordon, 2018). In this way, the economy balances at the
natural level, realizing both employment prospects and potential outputs. This balance remains
essential in bringing out the detailed perspective concerning the economic outlook versus what
requires exploration to adequately deal with the economic nature problems.
When looking at the Philips curve, in the short run, inflation anticipated gives a measure
of price changes. However, in the long run, inflation tends to adjust accordingly to the actual
inflation changes. What this then elicits is that the capacity of the Federal Reserve to create
inflation in the unexpected economy is a phenomenon only viable in short-run consideration.
Therefore, this means that once inflation has been anticipated, unemployment will come below
the natural rate by ensuring that the actual inflation level remains above the anticipated
threshold. When looking at the Philips curve under the circumstances, there is a rise in inflation
in the long run, while there is a shift to the right in the short run when high inflation is
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anticipated. The idea of effectively interpreting the problem gives clues on the effective
manipulation of the curve to realize the intended outcome. This then tends to bring out the
ideology concerning effectiveness in terms of looking at what has to be done amid the changes in
the unemployment situation. A clear direction on how to cut the impending issues becomes the
push factor to examine the natural rate and discover how the threshold impacts other elements.
US Unemployment and Inflation Data
In the short run, the Philips curve depicts an inverse relationship between unemployment
and the inflation rate (Hazell et al., 2022). This gives rise to a scenario with a tradeoff between
the two variables. When it comes to the long-run consideration, there is no tradeoff evident. This
translates to inflation increasing with unemployment as workers demand high wages to match
the cost of living. The available data tends to focus its economic projections on an area where it
is clear the economic predisposition the Federal Reserve has to deal with to accomplish its
mission. In the end, this determines the success of the endeavor to deal with inflation and
unemployment problems.
In the short-run, the unemployment rate under natural circumstances is pegged on diverse
aspects of the labor market. Some of those include the minimum wage policies. Equally, there
are other significant features, including the power unions have in the market, the role that
efficient wages play, and the effectiveness associated with undertaking a job search (Gagnon and
Collins, 2019). The Federal Reserve controls the inflation rate in the economy. This is dependent
on the amount of money that it allows in circulation.
Still, with the concept of short-run tradeoffs, society maintains the problem of
unemployment and inflation. Shifting the card to policy-makers in their quest to increase
aggregate demand limits unemployment immensely (Hazell et al., 2022). However, this happens
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at the expense of experiencing higher inflation situations. A decision to contract aggregate
demand has the effect of decreasing inflation. Nonetheless, this happens at the cost of
experiencing a situation with an increasingly high level of unemployment.
The presentation of the Philips curve, in the long run, is a straight line that is vertical,
highlighting the natural unemployment rate. It does not depict any pressure on wages or
inflation. Therefore, with an increase in the aggregate demand to reduce unemployment, there is
an increase in unemployment, and inflation is in effect. Therefore, given the circumstances, the
recent US 20-year inflation and employment statistics show the long-run data, hence failing to
confirm the Philips curve in the short-run (Gagnon and Collins, 2019).
Unemployment and Inflation Data Approves or Disapproves
In the short run, the Philips curve presents a tradeoff between the inflation and
unemployment variables (Mendez, 2019). However, the stagflation ideology tends to prove this
model wrong due to unpredictability and instability. Aggregate demand leads to real output rise,
which affects unemployment. This means that more employments stretch more into the
economy. Inflation due to an increase in aggregate demand is referred to as demand-pull, making
prices of commodities surge (Mendez, 2019). This aspect is evident in the short run, and the
available data in the US currently is significant proof of the same. The data workings then
demonstrate that it is not possible to apply the short-term period concepts in totality. While
focusing on the data to answer the question of unemployment and inflation, it emerges that the
information depicts the ideal economic situation in the US, contributing to effectiveness in
handling the outcomes.
Philips Curve Application
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The Philips curve cannot resolve the issue of unemployment and inflation in the current
economic dispensation; neither can it forecast the concepts adequately. This is owing to the view
of unemployment and inflation as causal aspects, misconstruing their manifestation (Hall and
Sargent, 2018). In reality, whenever there is a change in aggregate demand, it leads to a
corresponding change in inflation and unemployment. Therefore, in its realization, the Philips
curve misinforms policy makes, swaying them from the aspects to focus on in dealing with the
monetary policy issue. The view on the Philips curve is that it is accurate when dealing with a
weak economy, and the converse holds.
Frankel (2011) argues that low unemployment is a precursor to a tight labor market. This,
in effect, contributes to a significant upward push for wages courtesy of the labor costs on the
commodity prices. Some may believe a low unemployment rate to be a good thing and while this
is generally true, there is such a thing as having too low of an unemployment rate. If
unemployment is too low then companies would struggle to find employees to fill positions. This
could lead to lower production, and higher prices. Even though the use of the Philips curve is
evident and has remained relevant over the years, it does not give a true picture of its reliability
as a tool to solve inflation and unemployment. This is owing to the interplay between monetary
policy aspects and the figures that the Philips graph may represent. In essence, it appears logical
to deal with the issues surrounding inflation and employment differently, as opposed to relying
on the Philips curve. Nonetheless, despite the unreliability and the dormancy of the Philips curve
over the years, it remains a critical tool for analysis and presentation of the employment and
inflation economic aspects. This is because it explains and brings out those issues critically,
helping solve many of the impending assertions on the ideas. Whereas its validity cannot be
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approved presently, it might still find significant relevance in the coming days, meaning that it
cannot be wished away.
Policy Recommendation
The debate on which is better between monetary policy and fiscal policy continues to
elicit diverse opinions among experts. Nonetheless, what remains intact is the fact that each of
the policies has its advantages and disadvantages. Therefore, in the wake of deciding on the ideal
policy to steer the economy, then it is paramount to examine each of those policies against the
economic outlook at the time and the intended outcome versus the pros and cons of each present.
This becomes an ideal strategy for coming up with sound decisions on what one requires to
effectively decide on the policy to apply to the economy. In its presentation, the Philips curve
continues to remain a poor guide on the issue of monetary policy. However, dealing with this
may require alternative approaches. Hongo et al. (2020) consider the idea of incorporating fiscal
side policies together with feasible labor supply as ideal alternative mechanisms to deal with the
problem. This then becomes a positive step in focusing energies towards a direction that will
establish economic stability.
The use of monetary policy in dealing with inflation and unemployment is ideal in the
short-run and long-run economic milestones. In this policy, controlling the wages and prices will
become an effective tool in the manipulation of this aspect. Federal Reserve will roll out the
price action recommendation for people for products and services. While at it, it will regulate the
wages for workers in different sectors by setting the minimum and maximum levels. In this way,
it will have unemployment settled by preventing workers from influencing high wages. This
makes it affordable for employers to employ many people, solving the issue of a low
employment rate. Consequently, with regulated wages across, it means that consumer power
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remains at a certain level. This eventually presents a scenario where consumers will lack the
power to influence the upward surge of prices. In effect, this minimizes the inflation effect bound
to rock the commodity prices in many sectors. Working on the monetary policy then achieves its
mission of regulating the money demand and supply curve, which is critical in maintaining a
favorable balance across the variables.
The Philips curve considers the relationship existing between unemployment and
inflation negative. Therefore, expanding or contracting the aggregate demand requires choosing
a point along the curve with the respective demarcations on unemployment and inflation to deal
with the impending problem adequately. The tradeoffs between the two concepts tend to hold in
the short-run, as the Philips curve depicts.
Conclusion
Monetary or fiscal policies are essential in dealing with inflation and unemployment. The
two economic markets largely determine the measure of an economy in terms of its strength. The
effectiveness of the policies in dealing with inflation and unemployment makes them worth the
recommendation in solving the economic problems in the country. The idea of which is the best
policy depends on the alignment of each towards dealing with the economic problems. The
diverse opinions on what needs to be done or what to focus on to bring unemployment and
inflation to an all-time low are what remain critical. An overview of the Philips curve in the long
and short-run considerations as a mechanism for dealing with unemployment and inflation
establishes its presence as inadequate to curb the situations. However, working on other
modalities in this situation tends to provide an effective way to push the agenda in the struggle to
ensure that inflation and unemployment remain manageable.
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References
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for International Economics Working Paper, (19-6).
Gordon, R. J. (2018). Friedman and Phelps on the Phillips curve viewed from a half century's
perspective. Review of Keynesian Economics, 6(4), 425-436.
Fitzgerald, T. J., Jones, C., Kulish, M., & Nicolini, J. P. (2020). Is There a Stable Relationship
between Unemployment and Future Inflation? (No. 614). Federal Reserve Bank of
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Frankel, J. A. (2011). How can commodity exporters make fiscal and monetary policy less
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Hall, R. E., & Sargent, T. J. (2018). Short-run and long-run effects of Milton Friedman's
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Hongo, D. O., Li, F., Ssali, M. W., Nyaranga, M. S., Musamba, Z. M., & Lusaka, B. N. (2020).
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