International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
Revisiting of Philips Curve; a Case Study from Pakistan
Hameed Gul1, *Dr Khalid Mughal2, Ghayur Ahmad Kakar1, Atif Hussain3, & Sonia Khaliq1
1
MS Scholar Economics, 2Faculty, Preston University, Islamabad, 3Lecturer Mgt .Sciences, Preston
University, Kohat, Pakistan.
*drkhalid0@gmail.com
Abstract
This paper researches the validity of Philips cure in Pakistan whether inflation and unemployment is
negatively related or positively are linked. Now a day in the critical and serious, unstable condition,
inflation and unemployment both are continuously rising. We are facing the Political disputes and
terrorism situation, its consequences is also on economy and caused the badly devastated economy.
The noteworthy input of this paper is to enlighten the increasing inflation and unemployment and its
negative impact in the whole economy. In economics, the Phillips curve is a chronological contrary
association between the rate unemployment and the rate inflation in an economy. It is acknowledged
clearly, the lower the unemployment in an economy, the higher the rate of inflation. Theories
pedestal on the Phillips curve recommended that this could not come about, and the curve appeared
under a determined attack from a group of economists headed Milton Friedman who disagreed that
the Phillips curve relationship was only a short-run phenomenon. He disagreed that in the long-run
employees and employers will seize inflation into relation, resulting in employment agreement that
increase pay at rates near expected inflation. Correspondence to survey high inflation are having the
same course as the previous survey and defendant are of view that Pakistan was facing inflation due
to food prices, bad governance and oil prices and monetary policy has no effective control.
Government has always intended to stabilize the economic stability, but inflation prevents economic
growth, suspicious situation for consumers, entrepreneurs, investors decline the value of income and
saving. High inflation just promotes tentative behavior is rather productive aptitude. A reliable
monetary policy escort to lower interest rates promotes creative investment rather speculative
actions
Key Words: Philips Curve, Inflation, Unemployment, Economic Growth, Bad Governance, Reliable
monetary policy
1. Introduction
William Phillips, a New Zealand born economist, wrote a paper in 1958 titled “The Relation between
Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom”, 1861-1957,
which was published in the quarterly journal Economics.
In economics, the Phillips curve is a chronological contrary association between the rate
unemployment and the rate inflation in an economy. It has been acknowledged clearly, the lower
the unemployment in an economy, the higher the rate of inflation. While it has been observed that
there is an established short run tradeoff between unemployment and inflation, this has not been
observed in the long run.
In the paper, Phillips depicted how he observed an inverse relationship between money wage
changes and unemployment in the British economy above the time tested. Similar configurations
were found in other countries and in 1960 Paul Samuelson and Robert Solow took Phillips' work and
made precise the link between inflation and unemployment when inflation was high, unemployment
was low, and vice-versa.
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International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
Economic growth, inflation and unemployment, these are mega concerns of every economy, united
States and other like country are much conscious and for the targets to get accomplish swift
economic growth, it also effect to find the job for that reason unemployment rate is low rather than
high, speedy inflation could eradicate the saving of consumer
Government could manage unemployment and inflation with a Keynesian policy. They could put up
with a reasonably high rate of inflation as this would escort to lower unemployment - there would
be a trade-off between inflation and unemployment. For example monetary policy and fiscal policy
deficit expenses could be used to fuel the economy, gross domestic product and lessening the
unemployment rate. Moving along the Phillips curve, this would escort to a higher inflation rate, the
cost of enjoying less unemployment rates.
As unemployment drop, some labor scarcity may take place where experienced labor is in short
supply. This place additional strain on wages to rise, and since wages are generally a high percentage
of total costs, prices may go up as firms forward these costs to their customers. Increasing demand
and output lay anxiety on limited resources and can escort to suppliers lifting up prices to expand
profit margins. The threat of increasing prices is supreme when demand is surpass supply-capacity
leading to surplus demand (i.e. a positive output gap).
There is tremendous vibration in short-run in Brazil economy. In 80’s and 90’s there was found
severe difference in rich and poor as intense inequality of income distribution. During 80’s, in
municipal cities, it states that there was “mega inflation” and severe vibration in unemployment.
Economists were of view that “unequal education distribution” was intense base for unequal
income; it was states that if this inequality is eradicated then nearly 50% of unequal income of labor
force could be eliminated.
Types of Unemployment
Seasonal unemployment
It is also known as underemployment and it principally happens in which a person doesn't get the
type of work he is proficient of doing; he may poses skill and proficiency.
Disguised unemployment
When more people are occupied in some actions than the number of person requisite for that, this is
called disguised unemployment. For example: in an industry, on a machine, 8 labourers are required
to work on but are employed 10 labourers then this unemployment for 2 labours is called disguised
unemployment.
Frictional Unemployment
It is practised by a worker while he quits from one job and looks for another. Pertains for fresh
graduates productive part of economy amplifies workers long-term welfare and competence.
Classical Unemployment
It is real wage unemployment as well. Real wages are positioned above market clearing level
Structural Unemployment
This is caused due to disparity between job vacant by employers and potential workers. Pertain to
geographical place, proficiency, and many other aspects.
Cyclical unemployment
The aspect of unemployment is related to cyclical trend, carried out with business cycle in both
production and growth. When there is boom in the economy then cyclical unemployment is very low
whereas output production is at its height. Similarly, when there is low production in an economy,
calculated through GDP, we will see that business cycle is going to bottom and this cyclical
unemployment will increase.
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International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
The Demand-Pull and Cost-Push Inflation
Cost-push inflation
Cost-push inflation fundamentally means when prices “push up” by boost in costs of any of the four
factors of production (labor, capital, land or entrepreneurship) when corporations are previously
running at full production competence.
To envisage how cost-push inflation functions, using a plain price-quantity graph showing expressing
happenings when Aggregate supply curve shifts. The graph express the level of output, is attained at
each price level. As costs of production rises, aggregate supply diminishes from AS1 to AS2, causing a
rise in the price level from P1 to P2. The justification after this rise is that, for corporations to uphold
(or increase) profit limits, they will need to move up the retail price paid by consumers, thus causing
inflation.
(Appendex-1).
Demand-Pull Inflation
Demand-pull inflation takes place when aggregate demand rises, classified by the four sections of
the macroeconomics households, businesses, governments and foreign buyers. When these four
sectors concomitantly want to acquire more output than an economy is able to produce, they
contend to buy restricted amounts of goods and services. Consumers' fundamental nature is to
“propose prices up”, causing inflation. This extreme demand is also referring as “too much money
chases too few goods”, generally takes place in a growing economy.
Demand-pull inflation is a rise in aggregate demand that is more rapidly than the equivalent boost in
aggregate supply. When aggregate demand boosts without a change in aggregate supply, the
‘quantity supplied’ will increase. Coming across once more at the price-quantity graph, we observe
the association between aggregate supply and demand. If aggregate demand amplifies from AD1 to
AD2, in the short run, this will not (shift) aggregate supply, but change in the quantity that is
supplied in same Aggregate supply curve. The foundation following that supply curve is not shifting
because the Aggregate demand increases more rapidly than aggregate supply in an economy. As
corporation raise production, the cost to produce each supplementary production boosts, as
signified by the transform from P1 to P2. The justification behind this alteration is that to meet the
need of demand, firm has to pay more to its labor for overtime work or employ more machinery,
thus escalating the cost of production. Just like cost-push inflation, demand-pull inflation can occur
as corporations, to preserve profit levels, forward the higher cost of production to consumers’
prices. (Appendex-2).
“PIDE Inflation Expectation Survey” imitates the views regarding different variable including
inflation, economy situation and monetary policy performance. People are looking forward low
inflation as was in preceding months. There is cost push, demand-pull and some constitutional
aspects that are accountable for inflation in Pakistan, as usual Govt. policies are invalid from January
to June 2010, and inflation expectation was 16.50%. The participation of cost-push 29.1% pursued by
demand-pull 14% and structural factors 18.8%, all together they make 56.1% inflation in 2010.
People were feared of inflation in different t consumer products. Some are of view that there will be
depreciation of exchange rate and appreciation of exchange rate and unemployment was also
expected to increases. Accordingly growth rate was expected to emerged was 2.086%. 67.5%
defendants were in support of low interest rate but some preferred high interest rate.
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International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
Problem Statement
This topic has been chosen for the reason, as Pakistan is facing the devastating economic situation,
with persistent extreme rise in prices, generating high inflationary situation. Unemployment is also
increasing as we are facing the energy crisis, load shedding of electricity and gas, consequently
industries are shutting down, production is decreasing as a result, labors are kick out of industries,
being given them low wages. Because of extremely rise in prices of goods, cost of production is
increasing, because of this reason producers are charging low wages to labors and have increased
working hours. Government is also charging high tax, so producers are putting those kinds of burden
on consumer.
There is instability and hazards to the sovereignty of Pakistan, because of terrorism threats and
attacks; most of foreign investors are reluctant to invest in Pakistan, and some are shifting their
capital to other developing countries, consequently labor force has gotten unemployed in recent
years.
As we know that inflation and unemployment are negatively inter-related, e.g. if inflation goes up
then unemployment goes down vise versa, according to Philips curve, but we observe in the case of
the economy of Pakistan, then we come to know that both inflation and unemployment is increasing
in the same direction means both are positively rapidly increasing. Through this paper study we will
try to find that Philips curve is still valid in Pakistan or getting failed, while taking into consideration
the recent situation.
Unemployment and inflation, both has become a common phenomenon that they are difficult to
control, as prices of daily consumable goods are increasing, as there is no control by the authority.
Our economy is facing cyclical and structural unemployment at the same time, as our economy’s
business cycle is going down now a day and job seekers do not find the job according to their
education, skills, expertise etc.
This study would help us to find the true situation of inflation and unemployment, and we can give
suggestion to authority, what is the basic problem and how we can be able to solve and see as to
what are the hidden problems, that are causing to raise both inflation and unemployment
simultaneously.
Literature Review
An important issue discussed in several development literatures is the relationship between Inflation
and Unemployment. The resultant of effect of central bank over the administrative power of
controlling the wage deal and the links between organizational variable on real wages,
unemployment and inflation in a support in which unions are antipathy to inflation, this provoke
central bank to effect the wage demand at lower inflationary rate. It has different directional effect,
lessen the replacement of labor mobility to different unions and competition increase real wage
unemployment and inflation, but the decrease in unions also have modest impact inflationary
suspicious on the real wage demand in wage bargaining, unions acts according to macroeconomics
functioning. Unions not only considerate the results of employments and real wage but also inflation
rate under centralized wage setting. (Alex, Francesco, 1999).
There is tremendous vibration in short-run in Brazil economy. In 80’s and 90’s there was found
severe difference in rich and poor as intense inequality of income distribution. During 80’s, in
municipal cities, it states that there was “mega inflation” and severe vibration in unemployment.
Economists were of view that “unequal education distribution” was intense base for unequal
income; it was states that if this inequality is eradicated then nearly 50% of unequal income of labor
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International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
force could be eliminated. Recession and MI also make worse unequal income. Both inflation and
unemployment are responsible for creating inequality. It’s only the macroeconomics policy that
leads to equality. Recession is a big cause of creating trouble as poor instantly lost their jobs, but in
recovery period thy get back the job, middle class have to sell their assets in recession time and
become impossible to get back their assets. Recession has long lasting effect on income distribution.
Inflation lessens the disposable income; as a result increase poor community. Inflation forecasting is
difficult, nominal interest rate doesn’t show off the inflation rates. Inflation thus cost to wage
earners including vibration in real income. The clear cut waving doesn’t let one make consumption
or real disposable income just get end. (Eliana, Ricardo, Andre, January-1995)
Milton Friedman said that one of the most obvious phenomena in macroeconomics is that when
unemployment continues below its natural rate than inflation raises, which is called “NAIRU” the
researchers tried to fix what was the rate of NAIRU, was it 5.8%, and calculated by CBO (1996)? Or
5.7% by CEA (1996)? Or 5.6% anticipated by Gordon. As during 1995 and 1 st two quarters of 1996,
unemployment stayed close to 5.6%, it had taken to argue for policy makers and economist that
whether it was reduction in NAIRU and more specifically it was thought that unemployment and
NAIRU had to be pointer to agitated economy. There was debate that NAIRU’s current value, or it
had reduced in recent year or whether would it be helpful in estimating inflation from statistical
indicators that it had changed during 30years and reduced nearly 1% point from its climax in early
80’s and recent anticipated value was around 5.5% to 5.9%. (Douglas, James, Mark, 1997)
Most economies of the world are facing the socially devastative inflation usually high
unemployment, exploitation of economic resources, containment of human sovereignty because of
poor Government policy and results accordingly, the issue of the relation between inflation and
unemployment is a contentious political subject, it had been entangled with contentious with
respect to the performance of monetary, fiscal and other aspects that manipulate aggregate
demand, the change also was affected by aggregate nominal demand which have effect on
employment, the change on employment and price level was affected by the degree of vary in
aggregate nominal demand. Friedman said correspondence to the Philips there is negative
relationship between unemployment and rate of change in wages as high level of unemployment
with low wage. (Friedman, 13th Dec 1976).
There are considerable change in the economies of several European countries, UK had considerate
favorable progress in labor, financial and foreign exchange market, Poland transformed to liberal
economic form centralized system and Italy showed some suppleness in labor marked, the
advancement of unemployment is interlinked to productivity, inflation and real earnings and also
lived between earnings and prices. It was drastic problem of unemployment in European economies
till 80’s, afterwards supple labor market strategy was followed “wage indexation mechanism” is one
of the indicator of inflation and its perseverance. Unemployment is an obvious phenomenon with
increment in real wage higher wage would to escort to change labor force increase the cost to firm,
definitely would direct increment in unemployment when the real wage increase its increase the
productivity and unemployment as positive relation. (Massimiliano, Grayham, 1999).
On the basis of “friction growth” which was explaining the link between nominal friction and money
growth to re-estimate inflation and unemployment tradeoff. In sticky prices as money supply
increase price regulation is unable to take consecutive change. There is perseverance of inflation and
unemployment in reaction of monetary policy shock and having connection to the slope of long-run
Philips curve, it would be rationally flat and downward slopping. Macro level stabilization is gained in
accordance with inflation-unemployment alleviate. When money supply decrease then there is
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International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
instant increase in unemployment but inflation reaction is slow and late, an oscillation in
unemployment escort to unsteadiness in inflation of NAIRU is constant. (Marika, Hector, Dennis, 5th
March 2004).
U.S economy boomed between 1995 and mid-2000 which has astonished the whole world. Output
productivity was so high and it was though effective to control the speedy production under the
supervision of Federal Reserve. The unemployment rate crawl yet lessens till 3.9% in 2000. Fed got
controls over such a way that short-term interest rate rejected to pick the pace; no less than during
1996-98, as the Philips-curve, inflation-unemployment swapping could be estimated. Inflation rate
that time neither hasten nor brake. The basic finding was “Did the Philips curve shifts its position or
even disappear entirely?” The renewal of productivity growth and the economic prosperity are
directly and indirectly. The pace of output production is not equal to real wage growth while
reducing labors’ income reduce down the stress on inflation real-wage growth would be predicted to
increase in the same ratio as production revolutionize if labor’s participation is stable in the longrun. (Jon, Robert, 25-26 May, 2002)
Economic growth, inflation and unemployment, these are mega concerns of every economy, united
States and other like country are much conscious and for the targets to get accomplish swift
economic growth, it also effect to find the job for that reason unemployment rate is low rather than
high, speedy inflation could eradicate the saving of consumer. (Robort, 2004).
“Inflation uncertainty” is estimated through “inflation forecast” estimation. The facts show that
inflation uncertainty prominently raises the level of unemployment, reduction in growth and output
production. (Hafer, 1985).
Philips Curve shows negative relation between inflation and unemployment and position with
economic growth and inflation. As it has strength in strategy making and prediction device. But
today’s observation says something different regarding these relations. Krista has tested the
relationship between product augmentation and inflation and indicates that the practical
relationship is responsive towards development. As what a Philips Curve says it was keystone in
strategy making in US for many years. But it seems weak now as unemployment and inflation both
has fallen down. Yardini says that as we are in era of technology-stimulated productivity and
worldwide war, stiffed labor market is not managing blasting inflation. Philips Curve can be
unreliable for prediction and in strategy making for the economy as Philips Curve is ever foreseen
inflation in contemporary decades and enlarge the work of Kormendi and Meguire to estimate
whether the consequence are responsive to the time, they scrutinized (examined) and check the
correlation diverge diagonally developed vs. developing countries. (Krista, Oct, 1999).
A decreasing/recessionary monetary shocks increases unemployment that is most probably
temporary in the short run, but it has late after affects and steady decline in inflation, then price
regulation becomes impossible in such condition the short-run trade off between inflation and
unemployment is a big hurdle in way of business cycle theory and the results of monetary policy
with the price regulation is mysteriously a riddle for business cycle theorists. (Mankiw, Aug 2000).
Long-run unemployment is helpful in the adjustment of price and wage labor market theory
estimate that this type of unemployed is less concern in wage determination that “newly
unemployed”. “Macroeconomic adjustment mechanism”, e.g. decreasing stress on wages and
inflation will not function and unemployment comes out to be weak sign of operation labor supply, if
long run unemployment gone high. (Ricardo, Feb 2005).
“PIDE Inflation Expectation Survey” imitates the views regarding different variable including
inflation, economy situation and monetary policy performance. People are looking forward low
58
International Journal of Business and Behavioral Sciences
Vol. 2, No.6; June 2012
inflation as was in preceding months. There is cost push, demand-pull and some constitutional
aspects that are accountable for inflation in Pakistan, as usual Govt. policies are invalid from January
to June 2010, and inflation expectation was 16.50%. The participation of cost-push 29.1% pursued by
demand-pull 14% and structural factors 18.8%, all together they make 56.1% inflation in 2010.
People were feared of inflation in different t consumer products. Some are of view that there will be
depreciation of exchange rate and appreciation of exchange rate and unemployment was also
expected to increases. Accordingly growth rate was expected to emerged was 2.086%. 67.5%
defendants were in support of low interest rate but some preferred high interest rate. (Abdul
Qayyum, Javid, Kashif, 2009).
Some experts attach inflation, economic situation and monetary policy performance with the
consequences of March 2010, where large number of people anticipated as high inflation as 9% .The
defendants were sure that low interest would be feasible and 43% said that growth rate will rise and
26% anticipated that it will decrease. Most people are of the view that neither monetary nor fiscal
policy is acceptable in isolation but these equally applicable at the same time. March 2010 inflation
rate came out to be more than forecasted. Global financial crisis utility prices are more contributor
of inflation. (Abdul Qayyum, Javid, Kashif, 2010).
PIDE carry out quarterly inflation anticipation survey to present alignment on inflation anticipation
economy’s position. The Govt. pronouncement about VAT is one of the major tool that participating
to be the cause of high inflation and policy reliability. According to anticipated situation, 48.2%
defendant said that growth rate would not change following the situation. Mass of the defendant
said that consumer price index will rise in following years and also said that contracted monetary
policy is not valuable instrument in controlling inflation. Both monetary and fiscal policy should be
implemented. According to findings, inflation was caused by many of factors like oil prices, bad
governance. Food prices, global crises, utility prices, money supply fiscal deficit, wage etc. to control
inflation SBP had increased policy rate by 50 basis point to 13%, with implication from 2 nd August
2010. But Govt. was also borrowing, causing increment liquidity in the economy leading to price
explorating, so it was suggested that both monetary and fiscal policy should be used to control
inflation. (Abdul Qayyum, Javid, Kashif, 2010). (Appendex-).
According to the survey it was anticipated that recent fiscal year will observe high inflation 9.5%,
unemployment and dormant growth and also monetary policy would be unable to control,
persistent high inflation renewed GST, policy reliability and law and order were chief aspects lasting
high inflationary anticipations. Price steadiness is measured as the main purpose of central bank, as
high inflation reduce welfare, investment atmosphere, output growth, and correspondence to high
unemployment. It also cause high budget deficit and low economic growth, accordingly
unemployment ratio will also be increased. (Abdul Qayyum, Javid, Kashif, 2010).
Correspondence to survey high inflation are having the same course as the previous survey and
defendant are of view that Pakistan was facing inflation due to food prices, bad governance and oil
prices and monetary policy has no effective control. Government has always intended to stabilize
the economic stability, but inflation prevents economic growth, suspicious situation for consumers,
entrepreneurs, investors decline the value of income and saving. High inflation just promotes
tentative behavior is rather productive aptitude. A reliable monetary policy escort to lower interest
rates promotes creative investment rather speculative actions. (Abdul Qayyum, Javid, Kashif,
March-2011).
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Vol. 2, No.6; June 2012
Correspondence to June 2011 survey it was anticipated that there would be high inflation and
unemployment again due to poor monetary rules and defendants were anticipating high
unemployment while seeing the current worse situation of policy and highly poor economic
performance. (Abdul Qayyum, Javid, Kashif, June-2011). (Appendex-4).
According to Friedman even if the labor market is in equilibrium, frictional and structural
unemployment always exist. He called it “natural” rate of unemployment. The NAIRU is very helpful
in carrying out the economic analysis and policies, as if unemployment decline far beneath the
NAIRU then inflation goes up until unemployment comes back to NAIRU. Same situation has
scrutinized equally at local and national level, but could not be found the result in Pakistan. Studies
being estimated are constant. To direct it’s “anti-inflation and anti-unemployment”, using available
annual data for 1973-74 and 2007-04, anticipated The Time-Varying NAIRU (TV-NAIRU).
Unemployment rate is an exclusive parameter/pointer, depicted as a percentage of recent
population. Pakistan’s five years plans are proved to be useless as failed to lessen the
unemployment rate.
“The unemployment rate for Pakistan exhibiting an in creasing trend over the period
1973-74 to 1980-81 while a decline is registered in 1981-82 and then it started increasing
again. It decreased again from 1983-84 to 1986-87; but remained constant during
1987-88 to 1988-89. The unemployment rate in 1990-91 jumped to 6.28 from the previous year’s
3.1%. The figure also shows that the overall unemployment rate is on a decline from 2005-06”.
(Farzana, Haider, Sajid, 2011). (Appendex-5).
Methodology
This particular segment converses the methodology that us going to be used in the study. First of all,
a concise explanation of the study vicinity is planned. It had also taking into discussion; the research
design data collection and data analysis are the method of the study.
The information needed to is that how the multiple variables are affecting the unemployment and
then unemployment is affecting the inflation; we know that through Philips Curve inflation and
unemployment are negatively related or they are positively related then Philips Curve would fail
here.
The sample has been taken from 1992 to 2010 and 19 observations are incorporated. The
information is secondary and taken from the various sources. The OLS/TSLS methods are being used
here. The method of least squares is credited to Carl Fried Rich Gauss, a German mathematician.
Under some of the specific hypothesis the least squares method is having some of the striking
statistical properties that has made this method one of the most influential and famous methods of
regression analysis. (Gujrati/ Sangeeta, Fourth Edition).
The model is included:
Y= β0+β X1+ β 2X2+ β 3X3+ β 4X4+ +Uit
Where Y is unemployment and X1, X2, X3, X4, are variables, which are affecting the unemployment
in Pakistan and Uit is the error term
Y = α0 + β0V1 + Uit
Where Y is Inflation, v1 is unemployment and Uit is error term.
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Schematic Model
Sub-Variable
Independent Variable
Dependent Variable
Interest Rate
Growth Rate
Unemployment
Changing Rate of Labor
Force
Inflation
Tax Rate
Hypothesis:
Hypothesis plays an important and influential function in research, which is prominently helpful in
solving the problems in the study. The hypothesis of the study is articulated in the subsequent
paragraph
H1:
Growth Rate has significant impact on Un-Employment.
H2:
Interest Rate has significant impact on Un-Employment.
H3:
Changing Rate of Labor Force has significant impact on Un-Employment
H4:
Tax Rate has significant impact on Un-Employment
H5:
Un-Employment is negatively related with Inflation.
H6:
Un-Employment is positively related with Inflation.
Pakistan Inflation Rate
The recent inflation rate is 11% as stated in October 2011. From 2003 to 2010, average inflation was
10.15%, chronological high interest rate was in August 2008 that was 25.33% and evidenced low
inflation was in July 2003 that was 1.41. Inflation rate indicates the common increment in prices that
is calculated against the purchase power parity. The prominent measurements of inflation are CPI
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that calculated consumer prices and GDP Deflator that calculates the inflation of an economy.
(Appendix-6).
Pakistan Unemployment Rate
The Unemployment rate (10 years and above) was 5.95% in 2010-11 in Pakistan. Average
unemployment rate from 1990 to 2009 was 5.85 approaching a chronological high 8.27% in
December 2002 and evidenced low of 3.13 in December 1990. The labor force is depicted as the
people who are in work force and who are looking for the job. The non-labor force contains those
who are sitting idle means not searching the job and who are in Arm forces. (Appendix-7)
Theoretical Frame work
In economics, the Phillips curve is a chronological contrary association between the rate
unemployment and the rate inflation in an economy. As acknowledged cleanly, lower the
unemployment in an economy, higher the rate of inflation. While it has been observed that there is
an established short run tradeoff between unemployment and inflation, this has not been observed
in the long run.
3.1
Historical background of Philips Curve and Basic Concept
William Phillips, a New Zealand born economist, wrote a paper in 1958 titled “The Relation between
Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom”, 1861-1957,
which was published in the quarterly journal Economics.
In the paper, Phillips depicted how he observed an inverse relationship between money wage
changes and unemployment in the British economy above the time tested. Similar configurations
were found in other countries and in 1960 Paul Samuelson and Robert Solow took Phillips' work and
made precise the link between inflation and unemployment when inflation was high, unemployment
was low, and vice-versa.
In the 1920s an American economist Irving Fisher noted this kind of Phillips curve connection.
However, Phillips' inventive curve illustrated the behavior of money wages. In the years subsequent,
Phillips’ 1958 paper, many economists in the highly developed industrial countries believed that his
results showed that there was a permanently steady connection between inflation and
unemployment.
3.2
Government Policy
One suggestion of this for government policy was that governments could manage unemployment
and inflation with a Keynesian policy. They could put up with a reasonably high rate of inflation as
this would escort to lower unemployment - there would be a trade-off between inflation and
unemployment
For example monetary policy and fiscal policy deficit expenses could be used to fuel the economy,
gross domestic product and lessening the unemployment rate. Moving along the Phillips curve, this
would escort to a higher inflation rate, the cost of enjoying less unemployment rates.
If the Govt. required reducing the unemployment rate, it could boost aggregate demand but, even
though this might momentarily amplify employment, it could also have inflationary proposition in
labor and the product markets.
3.3
What is Trade-Off
The solution to sympathetic this trade-off is to consider the possible inflationary influence in both
labour and product markets come up from an increase in national income, output and employment.
3.3.1 The Labour Market
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As unemployment drop, some labour scarcity may take place where experienced labour is in short
supply. This place additional strain on wages to rise, and since wages are generally a high percentage
of total costs, prices may go up as firms forward these costs to their customers.
3.3.3 Product markets
Increasing demand and output lay anxiety on limited resources and can escort to suppliers lifting up
prices to expand profit margins. The threat of increasing prices is supreme when demand is surpass
supply-capacity leading to surplus demand (i.e. a positive output gap).
3.3.3 Other factor markets
Cost-push inflation can also arrive from increasing demand for commodities such as oil, copper and
progressed finished goods such as steel, concrete and glass. When an economy is flourishing, so
does
demand
for
these
machinery
and
raw
materials.
3.4
Explaining the Phillips Curve concept using AD-AS and the output gap:
Let us think the enlightenment for the trade-off using AD-AS study and the perception of the output
gap.
3.4.1 The long-run and Short-run AS and the AD and Output Gap
In the diagram, we represent the LRAS curve as vertical - this formulates the assumption that the
productive facility of an economy in the long run is free of the price level.
We observe an external shift of the AD curve (e.g. caused by a large increase in consumer
expenditure), which takes the equilibrium level of national output to Y2 away from possible GDP Yfc.
This generates a positive output gap and it is this that is considerate to basis a rise in inflationary
strain as depicted on top of. Surplus demand in product markets and factor markets causes a
increase in production costs and this escorts to an internal shift in short run aggregate supply from
SRAS1 to SRAS2. The decline in supply bears the economy back towards possible output but at a
higher price level. (Appendix-8).
3.4.2 The Phillips Curve idea
The above explanation and the diagram surely help to explicate the Phillips Curve idea. We possibly
will likewise exercise a diagram that exercises a non-linear SRAS curve to display the original shortrun Phillips Curve and the trade-off between unemployment and inflation: (Appendix-9).
Prior to the 1960s, a left ward movement beside the Phillips curve illustrated the path of the U.S.
economy. This move was not a subject of settling on to attain low unemployment in so far as an
unexpected side effect of the Vietnam. In other countries, the economic explosion was more the
result of careful policies since 1974 seven Nobel Prizes have been given for work critical of the
Phillips curve. Some of this criticism is based on the United States' practice during the 1970s, which
had periods of high unemployment and high inflation at the same time.
3.5
The NAIRU: A Criticism on Philips Curve
Stagflation in the 1970s, many countries practiced high levels of together inflation and
unemployment also known stagflation.
Theories pedestal on the Phillips curve recommended that this could not come about, and the curve
appeared under a determined attack from a group of economists headed Milton Friedman.
Friedman disagreed that the Phillips curve relationship was only a short-run phenomenon. He
disagreed that in the long-run employees and employers will seize inflation into relation, resulting in
employment agreement that increase pay at rates near expected inflation.
Milton Friedman, who disapproved of the origin for the original Phillips Curve in a speech to the
American Economics Association in 1968, launched the idea of the NAIRU. Economists both in the
United States and the UK have further developed it. Most important statistics raising the idea of the
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NAIRU in the UK include Sir Richard Layard and Prof. Stephen Nickell at the LSE. Nickell is now a
member of the Monetary Policy Committee concerned in the site of interest rates.
3.5.1 What is “The NAIRU”?
The NAIRU is defined as the rate of unemployment when the rate of wage inflation is established.
The NAIRU supposes that there is deficient contest in the labour market where some workers have
combined bargaining power through membership of trade unions with employers. And, some
employers have a level of monopsony power when they procure labour input.
Correspondence of the perception of the NAIRU, the equilibrium level of unemployment is the result
of a negotiating process between firms and workers. In this model, workers have in their wits a
target real wage. This target real wage is inclined by what is experiencing to unemployment – it is
understood that the lower the rate of unemployment, the higher workers’ wage demands will be.
Employees will look for to negotiate their share of an increasing level of profits when the economy is
taking pleasure in a cyclical expansion.
Whether or not a business can assemble that objective real wage during pay discussions rely partly
on what is experiencing to labour efficiency and also the capacity of the business to relate a gain on
cost in product markets in which they control. In highly competitive markets where there are many
challenging suppliers; one would look forward to lower gains (i.e. lower profit margins) because of
competition in the market. In markets conquered by monopoly suppliers, the gain on cost is usually
much higher and possibly there is an amplified share of the ‘producer additional that workers might
decide on to negotiate for.
If actual rate decline beneath the NAIRU, theory recommends that the balance of supremacy in the
labor market lean to control to employees rather than employers. The outcome can be that the
economy practice acceleration in pay settlements and the growth of middling earnings. Ceteris
paribus, an increase in wage inflation will cause a rise in cost-push inflationary pressure.
3.6
The Expectations-Augmented Phillips Curve:
Customized appearances of the Phillips Curve that seize inflationary outlook into relation remain
significant. The theory goes under several names, with some deviation in its information, but all
modern accounts differentiate between short-run and long run effects on unemployment. The
"short-run Phillips curve" is also called the "expectations-augmented Phillips curve", since it goes
up when inflationary expectations increase, Edmund Phelps and Milton Friedman argued. In the long
run, this entails that monetary policy cannot influence unemployment, which regulate back to its
"natural rate", also called the "NAIRU" or "long-run Phillips curve". However, this long-run
"neutrality" of monetary policy does permit for short run oscillations and the capacity of the
monetary authority to provisionally reduce unemployment by escalating everlasting inflation, and
vice versa.
3.6.1 Expectations-augmented Phillips curve
An equation like the expectations-augmented Phillips curve also emerges in many recent New
Keynesian dynamic stochastic general equilibrium models. In these macroeconomics model with
sticky prices there is a positive relation between the rate of inflation and the level of demand, and
therefore a negative relation between the rate of inflation and the rate of unemployment. This
relationship is habitually called the "New Keynesian Philips Curve." Like the expectationsaugmented Phillips curve, the NKPC implies that increased inflation can lower unemployment
provisionally, but cannot worse it eternally.
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3.6.2
Adaptive Expectations
Friedman set up the concept of adaptive expectations – if people observe and practice higher
inflation in their daily lives, they add up to anticipate a higher average rate of inflation in future time
periods. And they (or the trades unions who signify them) may then integrate these varying
prospects into their pay negotiating. Wages often follow prices. A explode of price inflation can
generate higher pay declare, rising labour costs and eventually higher prices for the goods and
services we must and desire to buy.
3.6.2.1 The Short run Phillips Curve:
This is demonstrated in the following diagram – inflation anticipations are higher for SPRC2. The
consequences may be that higher unemployment is mandatory to keep inflation at a definite
objective level. The expectations-augmented Phillips Curve argue that challenges by the government
to decrease unemployment beneath the natural rate of unemployment by enhancing aggregate
demand will have modest accomplishment in the long run. The outcome is simply to generate higher
inflation and with it a raise in inflation prospects. The Monetarist school considers that inflation is
paramount restricted through tight power of money and credit. Believable policies to carry on top of
inflation can also have the favorable result of dropping inflation expectations – causing a downward
shift in the Phillips Curve. (Appendix-10)
3.6.2.2
The long run Phillips Curve:
The long run Phillips Curve is usually drawn as vertical – but the long run curve can shift inwards over
time.
An inward shift in the long run Phillips Curve might be because of supply-side enhancement to the
economy – and in particular a decrease in the natural rate of unemployment. For example labour
market improvement might be victorious in dropping frictional and structural unemployment –
perhaps because of better motivation to find work or add in the human capital of the employees
that progresses the professional mobility of labor. (Geoff Riley, 2006; Tutor2u, Wikipedia,).
(Appendix-11
3.7
Inflation Expectations
PIDE (Pakistan Institute of Economic Development) carry out quarterly inflation anticipation survey
to present alignment on inflation anticipation economy’s position. The Govt. pronouncement about
VAT is one of the major tool that participating to be the cause of high inflation and policy reliability.
According to anticipated situation, 48.2% defendant said that growth rate would not change
following the situation. Mass of the defendant said that consumer price index will rise in following
years and also said that contracted monetary policy is not valuable instrument in controlling
inflation. Both monetary and fiscal policy should be implemented. According to findings, inflation
was caused by many of factors like oil prices, bad governance. Food prices, global crises, utility
prices, money supply fiscal deficit,, wage etc. to control inflation SBP had increased policy rate by
50basis point to 13%, with implication from 2nd August 2010. But Govt. was also borrowing, causing
increment liquidity in the economy leading to price explorating, so it was suggested that both
monetary and fiscal policy should be used to control inflation.
Correspondence to June 2011 survey it was anticipated that there would be high inflation and
unemployment again due to poor monetary rules and defendants were anticipating high
unemployment while seeing the current worse situation of policy and highly poor economic
performance. (Qayyum, Muhammad Javid, Kashif Munir, 2010). (Appendix-12).
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Results & Discussion
First we peer through the impacts of various variables on unemployment.
Y= 10.9322-0.2533X1-0.4382X2+0.1302X3 +0.2097X4+4.9664
Dependent Variable: GUN (-1)
Sample (adjusted): 1993 2010
Included observations: 18 after adjusting endpoints
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
GGDP
GINR
GLF
GTR
10.93226
-0.253380
-0.438207
0.130255
0.209744
1.465466
0.127231
0.095403
0.118484
0.175045
7.459918
-1.991499
-4.593215
1.099346
1.198226
0.0000
0.0679
0.0005
0.2916
0.2522
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.757468
0.682842
0.618090
4.966455
-13.95191
1.859252
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob (F-statistic)
6.469000
1.097524
2.105767
2.353093
10.15028
0.000594
Where GUN is Growth of Unemployment Rate, GGDP is GDP Growth Rate, GINR is Growth of
Interest Rate, GLF is Growth of Labor Force, and GTR is Growth of Tax rate.
The dependent variable is Unemployment rate and the independent rate is GDP growth rate,
interest rate, change rate of labor force and tax rate. The method of least square is used in the data.
The sample is taken from 1992-2010 and here comes 19 observations.
H1:
H2:
H3:
H4:
GDP growth has significant impact on unemployment.
Interest Rate has significant impact on unemployment.
Growth of labor force has insignificant impact on unemployment
Growth of Tax Rate has insignificant impact on unemployment
Through estimated values, I have found the that if GDP growth increases by 1 unit on the average
then total unemployment decreases by 0.26744 the average, so there is negative relationship
between GDP Growth and Unemployment, if unemployment decreases from GDP growth is zero
then average growth of unemployment would be 10.2547. Units R-Square value is 0.581, which is
about 58% of the decrease in Unemployment, so unemployment definitely decreases by the
increment of GDP growth.
I have found the estimated value of interest rate effecting unemployment is that if interest rate
increases by 1 unit on the average then total unemployment decreases by 0.3995 the average, so
there is negative relationship between Interest Rate and Unemployment, if Unemployment
decreases from Interest Rate is zero then average growth of unemployment would be 10.2547. Units
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R-Square value is 0.581, which is about 58% of the decrease in Unemployment, so unemployment
definitely decreases by the increment of Interest Rate.
In the same way, through estimation, I evaluated that the labor force is positively related with
unemployment as labor force increases, unemployment also increases, while looking at the
estimated values, we see that if labor force increases by 1 unit on the average then total
unemployment also increases by 0.1302 the average, so there is positive relationship between labor
force and Unemployment, if unemployment increases from labor force is zero then average growth
of unemployment would be 10.2547. Units R-Square value is 0.581, which is about 58% of the
increase in Unemployment, so unemployment definitely increases by the increment of labor force.
In the last estimation, I estimated that if tax rate increases by 1 unit on the average then total
unemployment also increases by 0.2097 the average, so there is positive relationship between tax
rate and unemployment, if unemployment increases from tax rate is zero then average growth of
unemployment would be 10.2547. Units R-Square value is 0.581, which is about 58% of the increase
in Unemployment, so unemployment definitely increases by the increment of tax rate.
If we observe the sum of square residuals the hidden variables, which is also responsible in creating
the unemployment in some way or other.
While peering through all the estimation, we found different relationships of variables with
unemployment. If production increases in an economy, then definitely we need more labor to
employ in the production units like industrial, agriculture sectors, demand increases, to meet the
demand, more production increases need more labor to employ, consequently GDP growth
increases and unemployment decreases. But we see the positive relationship between labor force
and unemployment as labor force increases unemployment increases more than before, as there
always exists structural and cyclical unemployment. Then we need to employ more factors of
productions like more land and capital to overpower this unemployment. We do observe that if
interest rate is negatively related with unemployment, it would be in a way that when interest rate
increases investment decreases, because investors then discouraged to borrow the money from
bank on high interest rate, so they will not employ labor or will give low wages give birth to
unemployment. Through the estimation we see that tax rate and unemployment are positively
interrelated as tax rate increases producer have to pay more tax to the Govt. also the prices of
inputs that are being used in the production process, so the cost of production of industries
increases then they run short of profit that they got, now they left with the option to pay less wages
to the employees or dismiss them, its also that at low wages labor will quit from there as working
hours are more, thus increases unemployment.
Now we take in the relation of unemployment and inflation, which is also the main area of concern
and study.
Y= 8.2647-0.3816V1+107.2269
Dependent Variable: GINF (-1)
Sample (adjusted): 1993 2010
Included observations: 18 after adjusting endpoints
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
GUN
8.264725
-0.381693
3.762882
0.573336
2.196382
-0.665740
0.0431
0.0415
R-squared
0.026954
Mean dependent var
5.792778
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Adjusted R-squared
-0.033861 S.D. dependent var
2.546014
S.E. of regression
2.588761 Akaike info criterion
4.844675
Sum squared resid
107.2269 Schwarz criterion
4.943605
Log likelihood
-41.60207 F-statistic
0.443210
Durbin-Watson stat
1.851743 Prob (F-statistic)
0.515061
The dependent variable is inflation and the independent variable is unemployment. Here also the
method of least square is used in the data. The sample is taken from 1992-2010 and here comes 19
observations.
H5:
Unemployment is negatively related with Inflation
H6:
Unemployment is is not positively related with Inflation
Through estimated values, I have found that if unemployment increases by 1 unit on the average
then inflation decreases by 0.3816 the average, so there is negative relationship between inflation
and Unemployment, if inflation decreases from unemployment is zero then average growth of
inflation would be 8.2647. Units R-Square value is 0.02, which is about 2% of the decrease in
Unemployment, so inflation definitely decreases by the increment of unemployment.
We know that when unemployment decreases, or in an economy more labor are employed, so
employment increase, purchasing power increases, demand for production output increases,
demand for holding money increases, so there is circulation of money increases in an economy, it
will generate inflation automatically. Of course there are other more factors, which are also
responsible in creation inflation indirectly.
All in all, there is needed to improve the mechanisms, which are responsible for disturbing the
essential economic factors. Law and order circumstances must be preserved, enhanced and made
advantageous. Good governance, justice and decentralization process will definitely reorganize the
situation. In all the estimation that we have made, we come to the result that Philips Curve is still
valid in Pakistan, as inflation and unemployment are negatively inter-related accordingly.
Conclusion
Through the peer estimation, we found that inflation and unemployment is negatively inter-related
in Pakistan, from the observation from 1992 to 2010. So it is stated that Philips Curve is still working
in Pakistan Economy, as with the rise in inflation rate, unemployment has decreased down.
While peering through all the estimation, we found different relationships of variables with
unemployment. If production increases in an economy, then definitely we need more labor to
employ in the production units like industrial, agriculture sectors, demand increases, to meet the
demand, more production increases need more labor to employ, consequently GDP growth
increases and unemployment decreases. But we see the positive relationship between labor force
and unemployment as labor force increases unemployment increases more than before, as there
always exist structural and cyclical unemployment. Then we need to employ more factors of
productions like more land and capital to overpower this unemployment. We do observe that if
interest rate is negatively related with unemployment, it would be in a way that when interest rate
increases investment decreases, because investors then discouraged to borrow the money from
bank on high interest rate, so they will not employ labor or will give low wages give birth to
unemployment. Through the estimation we see that tax rate and unemployment are positively
interrelated as tax rate increases producer have to pay more tax to the Govt. also the prices of
inputs that are being used in the production process, so the cost of production of industries
increases then they run short of profit that they got, now they left with the option to pay less wages
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Vol. 2, No.6; June 2012
to the employees or dismiss them, its also that at low wages labor will quit from there as working
hours are more, thus increases unemployment.
Our half of the population is still unemployed. The employed labor force also not fully employed, as
there is disguise unemployment. Structural unemployment is also the major problem, as people do
not get the job according to their education, skills, professional ability, e.g. a software engineer is
employed in management department, as he has no work there. There is also the problem of cyclical
unemployment, as our economy’s business cycle is on recession, labors are getting unemployed due
to multiple crisis. The unskilled dismissed one has no way out to go other industries to get the job.
There is also the problem of cost-push inflation as prices of all factors of production are increasing,
causing the rise in the prices of different goods. And with the increase of Population aggregate
demand is also increasing, as four section of macroeconomic section Govt., households, businesses
and foreign buyers’ demand is increasing.
We know that when unemployment decreases, or in an economy more labor are employed, so
employment increase, purchasing power increases, demand for production output increases,
demand for holding money increases, so there is circulation of money increases in an economy, it
will generate inflation automatically. Of course there are other more factors, which are also
responsible in creation inflation indirectly.
In Pakistan, inflation rate is very high so because of persistent rise in prices of daily food prices utility
prices, oil prices, money supply, fiscal deficit, international crisis last but not the least one of the
most important bad governance. Our Govt. always has failed to achieve the target they set in budget
policy, not that failure but there is a trend of increasing debt burden on our economy as to fulfill the
promise according to budget allocation and financial plan. Accordingly, we are badly facing the
downtrodden economic condition. As from last few years we see that prices of outputs are
increasing on weekly or daily basis, which is a severe threat to the economy, resultant increasing
blind inflation. Due to extreme energy crisis, our industries are shutting down give birth to
uncountable unemployment. There is electricity and gas load shedding, both of their prices are also
increases particularly electricity, increasing the cost of production of industries, so producers would
not employ more labor, kick the existing employed labor out, give them low wages, creating
unemployment, increasing the product prices, generating inflation. There is terrorism attacks and
threats to the sovereignty of Pakistan, so foreign investors are quite afraid of and reluctant to invest
here and some of investors also shifting and have shifted their capitals to some other developing
countries, causing unemployment. Oil prices crisis also the talk of the town, its prices are talking to
sky, again causing the rise in multiple goods’ prices.
Recommendations
As Pakistan’s Economy is one of the greatest economy in the world and our economy is passing
through bad time and severe crisis. The basic problem is bad governance, political disputes
instability, threat to the sovereignty of our country, inefficient plans, and poor implementation of
the of those plans and failure in achieving the set targets, thus wastage of money and the debt
burden in increasing on our economy. There is about $70 billion debt burden on us.
There is need to improve the law and order, good governance, stability of Government till every five
years so that the projects that are executing, be completed then employment be maintained and
there would be no wastage of money, rather be able to payback those loans. There must be proper
fiscal and monetary policy and budget policy. Proper allocation of budget allocation in all major
sectors of economy, like health, education, infrastructure, agriculture and all types of industries, and
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should provide the subsidies to non-developed sectors to boost that sector, and so to enhance the
employment and control inflation.
Govt. should also control over the non-productive expenditure. Tax should be imposed on every
citizen and according to income and wealth, so there is quite enough revenue that there is no need
to borrow loans from foreign banks, IMF or World Bank, reduce down the debt burden. To provide
the security to the foreign investors and, must stop the terror attacks through complete arm forces’
security, so that employment is enhanced. Also induce and provoke and provide subsidies to the
producers to produce the goods of export quality, to increase the exports, then there is current
account surplus, so producers will produce more, for that they demand for more labor, decreasing
unemployment. The authority must also set price so there is no fear of high inflation, there is
definitely a ratio of increasing of inflation rate to some extent with increase growth in economy. But
that is not so bad, but would be if there is no output production, then prices go up.
Limitations and Delimitation
The problem in this study encountered was the availability of data. The second problem is that there
are some economic factors, which are related with social influence, the variables education,
smuggling, political instability, corruption, expectation, terrorism, etc are excluded.
The above areas also need special research in future so that people get acquaintance with them
also. There are some variables like low wages, are directly and indirectly effecting the inflation and
unemployment. There are many more variables, which are very helpful in conduction and carry out
study further.
Future Gap
I was unable to carry out the social factors and its effects of unemployment in Pakistan and its
effects on inflation rate. On the basis of this project, further research could be carried out on the
social factors of unemployment, like political instability, smuggling, expectations. There is also one
variable that is very authentic to estimate in rotation with unemployment is low wages, that I could
not find the data on it. These all variables are very helpful to execute this study further ahead and
can detect more problems, which are causing inflation and unemployment.
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www.investopedia.com
Economic Survey of Pakistan
PIDE Inflation Expectations Survey
Appendices:
Appendix-1
Cost-push inflation
Source: Investopedia
Appendix-2
Demand-Pull Inflation
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Source: Investopedia
Appendix-3
Causes of High Inflation
Source: PIDE Inflation Expectations Survey
Appendix-4
Trends in Actual and Expected Inflation
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Source: PIDE Inflation Expectations Survey
Appendix-5
Unemployment Rate
Source: Various Issues of Pakistan Labor Force Survey and Economic Survey of Pakistan from 1973 to
2008.
Appendix-6
Pakistan Inflation Rate
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Source: www.tradingeconomics.com/pakistan/inflation
Appendix-7
Pakistan Unemployment Rate:
Source: www.tradingeconomics.com/pakistan/inflation
Appendix-8
The long-run and Short-run AS and the AD and Output Gap
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Source: (Geoff Riley, Eton College, September 2006 Tutor2u-Macroeconomics; The Philips Curve,)
and (13 October 2011 Philips Curve; Wikipedia, the free Encyclopedia,).
Appendix-9
The Phillips Curve idea
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Appendix-10
The Short run Phillips Curve
Appendix-11
The long run Phillips Curve
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Appendix-12
Source: PIDE Inflation Expectations Survey
78