Inflation & Unemployment

Inflation and unemployment are two sides of the same economic coin, often interacting in complex ways that shape the health of an economy. The Phillips Curve is a classic economic concept that illustrates the inverse relationship between inflation and unemployment—suggesting that lower unemployment can lead to higher inflation and vice versa. However, this relationship isn’t always straightforward, and the theory of Rational Expectations argues that people anticipate future economic policies and adjust their behavior accordingly, sometimes nullifying the effects predicted by the Phillips Curve.

Inflation and unemployment are also influenced by the business cycle, the natural ebb and flow of economic activity. During periods of economic expansion, demand for goods and services rises, reducing unemployment but potentially pushing inflation higher. On the other hand, during recessions, demand drops, leading to higher unemployment and lower inflation.

Several theories, such as the Keynesian, Monetarist, and Real Business Cycle theories, offer different explanations for the business cycle and its impact on inflation and unemployment. These theories help economists understand how economies naturally fluctuate and what policies can be used to smooth out these cycles, aiming for a balance between stable prices and full employment.