Rising unemployment and inflation commentary. The above article Bah Humbug talks about the rising inflation accompanied with the rise in unemployment. Inflation is defined as [iii]A persistent increase in the Average Price level in an Economy an

The downbeat mood was compounded by new labor-market figures, which abruptly ended a surprisingly rosy period. The Office for Budget Responsibility (OBR), which now oversees official forecasts, said in late November that employment had already risen (and unemployment fallen) to levels it had previously thought would not be reached until the middle of 2012. The latest figures cast a shadow over that bright picture since they showed the jobless rate rising from 7.7% to 7.9%. That took the total back to 2.5m, the peak in this cycle that it had reached in early 2010.

Unemployment may soon exceed that if the latest figures are anything to go by. These showed the number of people employed in the public sector dropping by 33,000 between the summer and the autumn. The government’s hope has been that private firms will step into the breach as the public sector sheds jobs because of the harsh spending cuts it has announced. But that didn’t happen this autumn and, as a result, overall employment also fell by 33,000 over the same period. That is an ominous sign, given the fact that the OBR expects a marked slackening in GDP growth in the first half of 2011, with national output forecast to rise by just 0.3% in the first quarter, far less than the recent quarterly rate of 0.8%. The outlook for the labor market may look bleaker, but that at least suggests that the increasingly panicky talk about inflation has been overdone. The latest figures show average earnings rising by just 2.2% a year. Despite this, persistent overshoots have made it hard for the Bank of England to get across its message that spare capacity resulting from the recession should eventually bring inflation back on track. If unemployment does head up, the bank’s message will seem more plausible.

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   The above article “Bah Humbug” talks about the rising inflation accompanied with the rise in unemployment. Inflation is defined as “A persistent increase in the Average Price level in an Economy and is usually measured through the calculation of Consumer Price Index (CPI)”. We see the article mentioning unemployment, defined as “People who are of the working age but are without work, available and actively seeking unemployment”. The numbers of people that are unemployed are expressed as a percentage of the total labor force or the active economic population. Analyzing the current state of the economy we can see the presence of Stagflation, “the persistent high inflation combined with high unemployment and stagnant demand in a country's economy”.

As can be seen, the above article mentions the governments plans to have a budget deficit due to high consumer prices and increase required increase in the consumer taxes like VAT. Consumer prices are the prices that buyers in an economy have to pay for buying durable or non-durable goods. This phenomenon is measured by the CPI, which hence shows the rates of Inflation in an economy. CPI is “an index of the variation in prices paid by typical consumers for retail goods and other items” which is measured by the creation of a consumer goods representative basket that houses all the consumer products traded in a market. When the prices of the goods in a basket increase, they show the increase in the prices of consumer goods.

Main causes that increase the prices of such goods are consumer taxes. “A Value Added Tax (VAT) is a form of consumption tax. From the perspective of the buyer, it is a tax on the purchase price. From that of the seller, it is a tax only on the value added to a product”. The government of an economy annually releases a budget, which shows the annual income and expenditure of a country and henceforth houses the changes in tax rates accordingly. According to the article, we know the government plans to reduce the deficit in Budget.

Budget deficit is a situation when the government spends more that it receives in revenue. Government has made this decision seeing the condition of the economy fearing a depression/recession in the economy and hence having extremely high unemployment. This justifies the Increase in the Vat rates from 17.5% to staggering 20% as the government needs the revenue earned from this increase to support the budget deficit and carry on its precautionary measures to recover & stabilize the economy.

There is Walking Inflation of 3%-4% and as we know currently it is accompanied by the Stagflation. The economy basically has a Cost push inflation that “Occurs as a result of an increase in the costs of Production that leads to a fall in the Short run Average Supply”.

The current trend of the Stagflation in the can be explained and analyzed further with the concept of Phillips curve and the inflation-unemployment trade-off.

The Phillips Curve, invented by Alban Williams Phillips in 1958, presents an argument regarding the presence of an inverse relationship between the rate of change of money wages and the rate of unemployment. During the latter years, the curve was modified and now shows an inverse relation between Unemployment and Inflation rates. This is mainly because of he fact that wages are the main factor in the cost of production of a firm. It is this relation that is also frequently referred to a “trade-off”. The graphs below show the two curves respectively:

We see the article mentions that the inflation would continue to rise because of the actions government is undertaking to reduce the unemployment. This can be explained by the graph below:

The above graph shows the Phillips curve relationship through showing Aggregate Demand and Supply analysis. The “trade-off” theory says that as one variable decreases, the other increases. If the government has the objective of the government is to reduce unemployment, it would lead to an increase in the unemployment. In the graph above, the equilibrium is at the point Y1 at price P1.. If there exist too much unemployment then the government can use Keynesian Demand Management techniques to bring about an increase in Ad from, AD1 -> AD2. At one hand, this will lead to an increase an output and hence firms would employ more labor and hence the unemployment would decrease but due will cause a higher price level and thus more inflation.

As we know that there exists Cost-Push Stagflation, we can use deflationary demand side policies to effectively reduce the consumer price levels, it can sometimes lead to an increase in the unemployment and a fall in the national output. Hence we can say that the use of Demand-side policies would be ineffective, hence supply side policies are the way to go. Practically in inflationary economy it remains extremely hard to determine demand-pull or cost-push Inflation, the economists use a mix of these policies to deal with the situation. According to Phillips Curve, we use demand side policies to curb the cyclical demand-deficit unemployment however the concept highlights that these policies would not be able to deal with the already ever-existing Natural unemployment like seasonal.

The government of any country is solely responsible for the functioning of the economy and hence overcoming reduction in inflation is one of its main objectives. The presence of a rising inflation in an economy brings with it many externalities like:

1. Decrease in Purchasing Power:

As the income of the consumers remain fixed, inflation will lead to a change in the prices of all the products by “x” percentage and hence the real income of the people will go down due to which they would not be able to buy most of the products.

2. Effect on saving:

Assuming an inflation rate of 5%, then the real rates of interest offered by a bank would be negative and hence the value of the saved money has gone down hence it is better to spend.

3. Effect on Interest rates:

Banks earn revenue through charging of Interest rates, if there exist high interest rates in an economy then they too will increase the interests to earn positively.

4. Effect on International competitiveness:

A country with high inflation would not be able to export much due to the high prices of goods; imports would become more attractive.

5. Uncertainty and Labor Unrest:

Firms would be hesitant to invest in the economy due to economic instability, reducing economic growth; similarly workers would feel that their incomes are very low which would lead to conflicts with the trade unions.

Hence we can conclude that the Government can decrease the inflation using Demand side policies and unemployment as both the condition pose a great threat to the economy and also the government as it reduces it’s chances of getting re-elected.

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