• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Economic Commentary

Free essay example:

Name: Nicole Paulet Piedra

Commentary number: #3

Due Date: 03/02/2009

Source: Emma Ross-Thomas, (30/01/2009), European Inflation Rate Falls, Unemployment Increases, Bloomberg.com: News,http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aiRziT71Pbu4

Section: 3, Macroeconomics

Word count:  746 words

This article talks about a recent increase in the rate of unemployment in the Euro-zone countries due to the fall of the rate of inflation, which was caused by a decrease in the oil and commodity prices. In this commentary, I will analyze the relationship between these two economic problems, discuss their effects and evaluate the possible solutions.

Europe’s inflation dropped from 1.6% to 1.1% in the last two months. According to economic theory, such a fall in the general price level (PL) is not ideal because it limits economic growth. In this case, the decrease of inflation rate is caused by a raise in the short run aggregate supply (SRAS) due to the fall of the oil and commodity prices. This also reduces the consumer’s price expectations, therefore decreasing aggregate demand (AD). [See graphs]

The effects of this situation are double-sided. The fall in the European inflation rate will hurt people with variable incomes, and benefit people with fixed incomes. Due to the increase in the purchasing power of money, it will hurt borrowers and benefit lenders. As the value of money rises, savings will become more productive; however, it will cause a fall in expectations that reduces investment in the stock market. Finally, it will discourage the creation of new ventures; although, it will prevent future capital flight.

In addition to these effects, inflation provokes unemployment. The European Central Bank (ECB) has reported that its unemployment rate rose from 7.9% to 8% in December, as inflation decreased. In the European Union, anyone 15 years of age or older who is not working but available for work and actively looking for one is considered unemployed. This type of unemployment is classified as cyclical because it varies with the business cycle.

In order to understand better how unemployment relates to inflation, the economist A.W. Phillips did several studies showing that there is a trade-off between them. As inflation increases, people have more money in their hands. This will encourage the government to increase its spending, hence creating new jobs. Phillips designed a curve (PC) that portrayed the relationship between these contradictory macroeconomic goals. [See graph]


Increasing unemployment has the following economic and social costs:

  • According to Arthur Okun, for every 1% increase in unemployment, there is a 2.5% decrease in the real GDP which will increase government borrowing and budget deficit, leading to a raise in the indebtedness of the countries.
  • More unemployment implies more people insured by the social security programs; hence, the government welfare costs will increase. In addition, less people in conditions to pay income taxes will reduce government tax revenues.
  • Unemployment causes an increase in homelessness and, therefore, in street violence and crime. Similarly, it incites alcoholism and drug consumption, as well as immigration and suicides.

From the PC, it can be concluded that a higher inflation will decrease the rate of unemployment in the EU. This, according to the article, will be attempted by the ECB through the implementation of discretionary expansionary monetary policy, which consists in a raise in money supply and a decrease in interest rate, to increase AD and lower SRAS. This is a policy taken from the Neo-Keynesian macro-model that believes in interventionism and short run measures to prevent deflation. [See graph]

One of the strengths of monetary policy is the short recognition, decision and execution lags. According to economists Mendel Gordon and Milton Freedman, they vary from 5-10 months and 6-24 months, respectively. One of its weaknesses, identified by Neo-Keynesian fiscal activists, is the weak links between banks and borrowers. This means that, regardless the interest rate changes, expectations remain unchanged. Fiscal activists also believe that monetary policy works indirectly and, thus, more slowly; however, monetary activists claim that it is not slower than fiscal policy.

Finally, monetary policy would succeed in increasing the rate of inflation, although it is limited by cash leakages and volt cash. Moreover, Milton Freedman affirms that it may destabilize the economy because of insufficient information. Consequently, it is better to follow the K% rule which consists in the establishment of a constant money growth rate determined by the Central Bank.

This student written piece of work is one of many that can be found in our GCSE Economy & Economics section.

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Related GCSE Business Studies Skills and Knowledge Essays

See our best essays

Related GCSE Economy & Economics essays

  1. The Nature of Macroeconomics

    becomes a major cost to a business * More competition the more producers have to absorb cost increases themselves rather than pass them on to consumers * Inflation imported from abroad * Falling $A pushes up the cost for imports * Government budget problems Inflation analysis: Aggregate supply & aggregate

  2. Retailing In India - A Government Policy Perspective

    There are also a few prudential conditions on the sale of shares in unlisted companies and the above market price sale of shares in public companies. Domestic Policy The domestic policy framework affects all investment, whether the investor is Indian or foreign.

  1. An Empirical Investigation into the Causes and Effects of Liquidity in Emerging

    Mature market vulnerabilities had eased significantly with investors increasingly prepared to assume credit risk and interest rate risk in the search for yield. This led to high investor inflows into US corporate bonds, with signs of reduced investor discrimination between low and high rated issuers.

  2. This report will establish the opportunities and threats presented to Sony by the EU ...

    minute due to the fact there could be a multiple of them whereas achieving ahead what needs to be done so more time is given and things are done better. Sony have to oblige to the equal opportunity act because if they don't it could lead to them having a

  1. UK Membership of the European Monetary Union.

    The change over process to the introduction of the Euro will involve substantial menu costs for businesses and banks. Europe's labour and product markets are too inflexible to deal with the economic strains that EMU will put on them. If interest rates, exchange rates and fiscal transfers cannot be called

  2. Economics of European Integration

    For this reason European companies need to be considered as big consumers or customers for the electricity suppliers. Moreover, the total consumption by European companies occupies an important part of the electricity market. In the statistics of the Industrial Energy Agency1, we find the following figures (2001)

  1. What is macroeconomics?

    * Interest rates effect consumption = repayments on borrowed funds increase and opportunity cost of expenditure on consumer items increases (spend or save) * Fiscal policy = affects disposable income through taxes and level of government spending on goods & services * Monetary policy = affects interest rates --> cost

  2. The Quest for Optimal Asset Allocation Strategies in Integrating Europe.

    If the marginal investor of Dutch securities lives in Holland, and the marginal investor in French securities in France and they evaluate stocks relative to other stocks in their country, country portfolios may in part reflect the different sentiment of Dutch and French investors.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work