UK Inflation and Unemployment

Question 1

What is unemployment? How is this measured?

Answer 1

• ONS/ILO says that unemployment is out of work and actively seeking but cannot find the job
• Measured by Claimant Count and Labour Force Survey

Question 2

What does ‘flows’ mean about unemployment?

Answer 2

• Unemployment has ‘flows’ arounf the labour market
• Flows between employment, unemployment and economic activity
• ONS said that there was 75,000 net flow in half of 2020

Question 3

What is the idea on full employment? What was Keynes’ argument?

Answer 3

• Key economic objective
• Set by 1936
• 3 main types of unemployment- cyclical (demand deficient), structural, frictional
• Argued that macroeconomic policy should aim to minimise demand-deficient unemployment
• Impossible to obtain 0%, Beveridge (1944) said that full employment is around 3%

Question 4

What has happened to Keynesian ideology?

Answer 4

• Since 1960s/1970s, Keynesianism has declined and inflation-targetting has been seen as more vital
• Governments have started to look to more micro-objectives around unemployment, skills mismatch

Question 5

What is equilibrium unemployment?

Answer 5

• Involuntary unemployment, trade unions and monopsony oiwer suggests that LM are imperfect, hence a ‘market clearing’ wage is not achieved
• LM equilibrium: An unemployment rate that would occur in the absence of cyclical changes (frictional and structural)
• This is also the NAIRU/Natural Rate
• NAIRU-> unemployment level that keeps wage inflation stable

Question 6

What determined NAIRU?

Answer 6

• NAIRU comes from the bargaining process between firms and workers
• Workers have a target real wage, which depends on the overall state of the economy
• Businesses can meet these wages given their mark-ups and worker productivity

Question 7

What has happened to the NAIRU since 1985? Why?

Answer 7

• Falling since 1985
• Means economy can reduce unemployment, without wage rises
• Slower population growth and increased average age
• Volatile Oil prices
• Reduction in TU power and privatisation
• Benefits reforms

Question 8

What is potential GDP? How do you calculate this?

Answer 8

• Potential GDP is the quantity of real GDP produced at the NAIRU
• Actual GDP - Potential GDP = Output Gap
• If Output Gap > 0; NRU>unemployment rate

Question 9

What is Price Level?

Answer 9

• PL = the average level of prices and value of money
• Inflation is the increase of PL, deflation is the decrease of PL
• Measured by CPI (basket of goods)

Question 10

What are inflation cycles? When do they occur?

Answer 10

• LR; infation occurs if QoMoney > Potential GDP
• SR; many different factors contribute
• Demand Pull- From expansionary policy (stemming from rising AD)
• Cost Push- From rising costs to the firm
• Persistant increase means AD increases, therefore cost push spirals and stagflation follows

Question 11

What is the SR Phillips Curve?

Answer 11

• Considered to be a tradeoff between inflation and unemployment in the 1960s
• SRPC: Rate of growth of money wages linked to inflationary pressures, which leads to the key tradeoff
• This idea is that Governments will have to use policy to stay on a given point on the curve

Question 12

When did the SRPC dissolve? Provide some reasons for this

Answer 12

• 1970s OPEC crisis created stagflation, meaning that the SRPC broke down
• Toughest aspect was the changes in inflationary expectations [shifts PC right]
• Reasons include: collapse of Bretton Wood (1971), Barber Boom (1972) and spikes in growth of MS

Question 13

What does Friedman think about LRPC?

Answer 13

• In LR, there is no trade-offs between inflation and unemployment
• Inflation is caused by excessive growth in the money supply
• SR trade-offs will not persist due to expectations
• Wage/inflation expectations adjust for workers
• Price/cost expectations adjust for firms

Question 14

How to reduce unemployment below the NRU without inflation?

Answer 14

• You must manipulate peoples expectation on prices
• This was done by giving Bank of England independance in 1998
• This is also done by increased supply side capacity or increasing labour market flexibility

Question 15

What is the Phillips Curve equation?

Answer 15

• π(t) = γπ(t-1) + φEtπ(t+1) + θ(yd - ys) + wt
• Actual inflation = past inflation + expected inflation + output gap + supply shocks

Question 16

What happens to the LRPC when stagflation occurs? How can this be combatted?

Answer 16

• During the recession, movement from ‘A’ to ‘B’ is stagflation
• Movement along the invisible demand curve
• To combat this, you can expand AD, AD shifts right, inflation increases and unemployment decreases
• Allow markets to increase unemployment, this reduces wages and inflationary expectation, AS shofts inwards