Sample Economics Paper on Unemployment and Inflation

The relationship between inflation and unemployment is very crucial to a flourishing economy. A proper understanding of this association is vital to the macroeconomic policies of the country. A wrong comprehension of this relationship could lead to wrong policies aimed at reverting the effects of one while adversely fuelling the other. According to Binyamin Appelbaum, the two are inversely related (n.p). This relation means that policies aimed at reducing unemployment may end up inadvertently raising inflation, hence putting the economy at another risk. These two macroeconomic factors also have the tendency of causing a ripple effect when not properly addressed. Unemployment, for instance, affects the rate of aggregate consumption, and thus, it also affects the economic growth. Nevertheless, the biggest problem faced by several reserve/central banks remains striking a balance between these two to achieve the required macroeconomic objectives.

As aforementioned, inflation and unemployment have an inverse relationship that means an increase in one will result in a decrease in the other. A low inflation rate is preferred but the prospect of having a high unemployment rate makes the deal stale. On the other hand, a low unemployment rate is of immense economic benefit but the possibility of that creating a high inflation rate makes it inconsequential. The association between inflation and unemployment is well explained by the Phillips Curve named in honour of its proprietor Phillips.



The Philips Curve

From the graph above, an increase in unemployment results in a decrease in inflation though by a margin that is less than proportionate to the increase. An increase in inflation will similarly cause a decrease in unemployment. Of the two, the rate of inflation is more responsive than unemployment. This means instilling policies affecting the rate of inflation will yield better and consistent results. The inverse relationship between interest rates and the rate of inflation further support this argument.

The economic reasoning behind the Phillips curve is that economies can only target one of the two but not both. The reason being as an economy approaches low employment levels, workers will try to lobby for higher wages or companies may have to increases their wages in an attempt to keep their workers (Dear Dr. Dollar n.p.). This is because at low employment levels, work is no longer a scarce resource, and it can be attained with relative ease. As firms seek to raise wages, they end up doing so at the expense of the households by raising the prices of goods and services to raise profits and hence be able to afford higher wages. The Philips curve also reveals a positive relationship between employment and wages. Therefore, policies aimed at decreasing unemployment end up increasing wages.

Resolving the inflation-unemployment issue henceforth entails establishing and maintaining a trade-off between the two. Since reducing either below a certain required minimum may result in a drastic increase of the other, the reserve banks have to maintain these macroeconomic indicators within a certain range. Nevertheless, experiences such as the so-called stagflation of the 1970s characterized with simultaneous high rates of both unemployment and inflation discredited the notion of a trade-off between the two. Recent statistics have also shown that the United States is experiencing both low inflation and low unemployment. This is a constant bottleneck to the Federal Reserve Bank which is tasked with the responsibility of maintaining the two at an economically friendly level.

The Fed has to plan its next course of action since the low unemployment levels will drive up inflation if left unchecked. As a result, companies are already offering higher wages in an attempt to maintain their workers. Given the fact that prices rise quicker as unemployment declines, time becomes of greater essentiality. According to the Fed, the inflation rate has been relatively weak but nonetheless remained below the expected level of 2%. This level has been maintained for the previous five years causing alarm among some Fed officials. The current economic conditions are inverse to those of the 1970s since the Fed now has to deal with both low unemployment and low inflation. The events of the 1970s required the Fed to formulate appropriate courses of actions for an economy that was crippled by high unemployment levels coupled with high inflation rates. The Fed officials regard low unemployment as the more important indicator since they claim low inflation could be attributed to certain temporary exogenous factors such as a reduction in the prices of cell phone services.

The remedy to this situation has taken two different approaches with the point of contention being the timing of raising the Fed’s benchmark rates. Raising the benchmark rates will increase the cost of borrowing hence make capital expensive. Conversely, an expensive capital will limit investments and discourage job formation and growth. Some officials are of the idea that this move should be delayed so as to allow the jobs to grow. Low interest rates encourage job creation and development since the cost of borrowing, hence cost of capital, together with the risk involved are low. Enterprises are, therefore, able to borrow and develop their ventures. On the other hand, some officials anticipate that delaying this move could lead to a loss of public confidence hence making inflation expectations self-fulfilling. This has forced certain officials of the Fed to seek for a reassurance of rising inflation before voting for an increase in the Fed’s benchmark rates.

The Fed finds itself at the middle of two opposing information with one side claiming wage growth is sticky and low while others claim that it is steady and high. The uncertainty surrounding the federal government policy expected from the Trump administration makes affairs complicated for the Fed. The intentions to implement tax cuts and increase government spending mean the Fed has to be very objective in its endeavours to avoid being caught off guard. These acts by the Trump administration could boast the economy but raise inflation. As inflation rises, unemployment rates will reduce. However, the high inflation could push general price levels upwards and adversely affect the households. Given that the Fed’s most successful corrective measure keeps the Fed benchmark rate limiting the adverse effects of these factors remains possible and doable.





Appelbaum, Binyamin. Fed Officials Confront New Reality: Low Inflation and Low Unemployment. Retrieved November 28, 2017, from

Dear Dr. Dollar. Retrieved November 28, 2017, from