Unemployment & Inflation
Theoretical approach to the relationship between unemployment and
inflation
low unemployment → inflation?
Why?
A British Economist W. Phillips’ paper on changes in wages and unemployment (1958)
American Economists P. Sumauelson and R. Solow’s paper on inflation and
unemployment (1960)
Unemployment and Inflation
Low unemployment → inflation?
1. Low unemployment may result in inflation. Why?
When unemployment is low, workers’ bargaining position gets stronger, so the HR
department needs to set higher wages
↓
Higher wages mean higher costs for firms, so the marketing department will raise the
prices of output to cover the higher wage costs
↓
Once all firms have set higher prices, the economy will experience price inflation
2. An upswing in the business cycle is often associated with rising inflation
Stronger aggregate demand
→ higher demand for labor
→ lower unemployment
→ higher wages
→ higher cost of production
→ higher prices
, 3. A downswing in the business cycle → ?
Inflation versus Unemployment in the United States, 1900-1960
During the period 1900-1960 in the United States, a low unemployment rate was typically
associated with a high inflation rate.
Inflation versus Unemployment in the United States, 1948-1969
Theoretical approach to the relationship between unemployment and
inflation
low unemployment → inflation?
Why?
A British Economist W. Phillips’ paper on changes in wages and unemployment (1958)
American Economists P. Sumauelson and R. Solow’s paper on inflation and
unemployment (1960)
Unemployment and Inflation
Low unemployment → inflation?
1. Low unemployment may result in inflation. Why?
When unemployment is low, workers’ bargaining position gets stronger, so the HR
department needs to set higher wages
↓
Higher wages mean higher costs for firms, so the marketing department will raise the
prices of output to cover the higher wage costs
↓
Once all firms have set higher prices, the economy will experience price inflation
2. An upswing in the business cycle is often associated with rising inflation
Stronger aggregate demand
→ higher demand for labor
→ lower unemployment
→ higher wages
→ higher cost of production
→ higher prices
, 3. A downswing in the business cycle → ?
Inflation versus Unemployment in the United States, 1900-1960
During the period 1900-1960 in the United States, a low unemployment rate was typically
associated with a high inflation rate.
Inflation versus Unemployment in the United States, 1948-1969
