A positive alignment between unemployment and inflation makes a unique set of difficulties for financial policymakers. When economic output is increased and unemployment is reduced, inflation tends to rise, and when inflation is reined in, the economy frequently suffers.
Historically, inflation and unemployment have maintained an inverse relationship, as demonstrated by the Phillips curve. Low unemployment corresponds with higher inflation, while high unemployment correlates with lower inflation, and even deflation. This relationship makes sense from a logical perspective. When unemployment is low, more consumers have discretionary income to buy goods. When demand for goods rises, prices rise as well. Customers purchase fewer goods when unemployment is high, which reduces inflation by putting downward pressure on prices.
When inflation and unemployment are low, a positive correlation can be beneficial as well. The late 1990s had unemployment below 5% and inflation below 2.5%. The low unemployment rate was largely attributed to an economic bubble in the tech industry, and low inflation was caused by cheap gas and a tepid global economy. After the tech bubble burst in 2000, unemployment spiked and gas prices increased. From 2000 to 2020, this relationship was still clearly characterized by the Phillips curve, but it was much less pronounced.
In the midst of academic arguments and counterarguments, new theories continue to be developed. Across the globe, the empirical evidence of employment and inflation challenges and confronts economies, leading to a lack of clarity regarding the correct blend of policies needed to create and maintain an ideal economy.
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