Tradeoff between unemployment and inflation and factors to be considered

By | June 26, 2013

1.        Tradeoff between unemployment and inflation and factors to be considered

 

1.1    Tradeoff between unemployment and inflation

 

As mentioned above, tradeoff between unemployment and inflation was suggested by the research of New Zealand economist A. W. Philips, who in 1958 published an article that examined the historical relation between inflation and unemployment in the United Kingdom. Based on the 100 years’ data, his data traced an inverse relationship between the unemployment rate and the rate of change in nominal wages (McEachern 2011, p. 384). Tradeoff between unemployment and inflation was popular since then. And the logic behind the Phillips curve is based on the traditional macroeconomic model of aggregate demand and aggregate supply. Since it is often the case that inflation is the result of increased aggregate demand for goods and services, it makes sense that higher levels of inflation would be linked to higher levels of output and therefore lower unemployment (Beggs 2010). The relationship have been widely recognized especially in the developed nations.

 

1.2    Factors to be considered by policymakers before deciding to sacrifice employment for price stability or price stability for employment

1.2.1            Draw out the Phillips Curve of Malaysia

 

Different nations have different macro environment and economic and industrial structures, therefore it is very unrealistic for Malaysia to follow the well calculated Phillips Curve of other countries. It is recommended that the country based on the historical data draw out the Phillips Curve of Malaysia. The most significant meaning of drawing out the curve is that it provides framework for forecasting the unemployment changes based on the price control methods. For example, suppose inflation changes by 1%, and unemployment rate change by 1% as well, in general it is not advisible to allow the inflation rate to change significantly under this relationship; but if suppose inflation changes by 1%, and unemployment rate change by 0.001% only, alloawance for inflation changes would be largely increased.

 

1.2.2            International inflation and price level

Before deciding to sacrifice employment for price stability or price stability for employment, another factor that the policy makers need to take into consideration is the price level and also the inflation trend in the external markets. An example that we have mentioned above the forced price increase in energy product in Malaysia in the recent years which had been greatly contributed by the price increases in the international crude oil market. The negligence of the external price factors would probably result in the loss of country fortunes and the decreases of purchasing powers among its people. For example, if there should be an 10% inflation at average in the international market, but if domestically the Malaysia policy makers still control the price unchanged through various techniques, the international balance of payment would be a difficult challenge for the policy maker. And also because the price in the international market is significantly higher, the Malaysia people would earn less but spend more to buy the imported goods. This would result in the loss of national fortune and a number of relevant difficulties.

 

1.2.3            Economic policy targets and economy growth

 

As we have mentioned above, inflation level of a country usually benefit the business sector, and companies and business men would be stimulated to expand their business because product prices tend to rise faster than resource prices, therefore we can understand that why most governments would prefer to keep some degree but controlled inflation to foster and maintain faster economy development. And on the other hand, we have mentioned the fact that in the recent years, the government of Malaysia has been ambitious in government spending to boost the economic development and transformation and its key efforts are known as the Economic Transformation Programme and Government Transformation Programme. These two programs are efforts by Malaysia’s current Government to contribute to making the country a developed and high-income nation as per its Vision 2020. And considering these policy ambitions, suppose that a relatively higher inflation rate would encourage faster economic development, but higher inflation rate would on one hand promote job creation and reduction of unemployment, but on the other hand bring a number of challenges such as reduced life quality for the local people and devaluated cash for the cash holders. But obviously, under the current economic and political policies because the country is trying hard to become a high income country, it is more advisable that the country sacrifice the inflation but it is nor for the reduction of unemployment but for the fast raise of Malaysia which is of great significance because of the existence of middle income trap. “Many countries make it from low income to middle income, but very few actually make that second leap to high-income,” said Ardo Hansson, a World Bank economist in Beijing. “They seem to get stuck in a trap where your costs are escalating and you lose competitiveness.” (nytimes.com 2010), this is the general expression of middle income trap. In an economic perspective, the middle income trap is a situation where a country which attains a certain income (due to given advantages) will get stuck at that level. As wages rise manufacturers often find themselves unable to compete in export markets with lower-cost producers elsewhere; yet they still find themselves behind the advanced economies in higher-value products. This is the middle-income trap which saw, for example, South Africa and Brazil languish for decades in what the World Bank call the “middle income” range (about $1,000 to $12,000 gross national income per person measured in 2010 money) (economist.com 2011). And now, the government’s ambitious policies have been targeting in avoiding the country’s being getting into such middle income trap, it is advisable that inflation could be kept in a higher level to serve the economic growth.

 

 

 

Reference

 

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