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Inflation & Unemployment Relationship Phases: Phillips, Stagflation & Recovery

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  • 0:04 Inflation & Unemployment
  • 1:07 Cycle of Employment-Inflation
  • 3:03 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
High inflation and unemployment are two things we don't like to see in the economy. In this lesson, you'll learn about the relationship between inflation and unemployment and three distinct phases of this relationship.

Inflation & Unemployment

High rates of prolonged unemployment or high rates of inflation can cause problems for any economy. In fact, sometimes an economy can be plagued with both at the same time. Let's take quick look at the key terms and concepts we'll be using in our analysis of unemployment, inflation, and the relationship between them.

Inflation is simply the rate at which the general level of prices for goods and services are increasing over a period of time. Inflation makes dollars worth less because it takes more money to buy the same thing you bought in the past. For example, if inflation over the past year was two percent, it will take you an extra two cents to buy the same thing you bought a year ago for a dollar. It may not seem like much, but think about spending $200,000 on a house and those pennies can add up quickly.

We calculate the unemployment rate by determining what percentage of people in the labor force are not currently working. If you are not working and not looking for work, you are not in the labor force and are not counted as being unemployed.

Cycle of Employment-Inflation

The relationship between unemployment and inflation is not static, it cycles through different phases. Economists refer to this process as the inflation-unemployment cycle.

We'll start with the Phillips phase of the inflation-unemployment cycle. Here, we see the standard relationship illustrated by the Phillips curve named after A.W. Phillips, a 20th-century economist who analyzed the relationship between inflation and unemployment. In a nutshell, the Phillips curve demonstrates that there is an inverse (i.e., negative) relationship between unemployment and inflation. In other words, in the short-term, as the rate of unemployment goes down, the rate of inflation will go up.

Phillips Curve

This discovery has given policymakers a tool to deal with unemployment, but there is a tradeoff. Governments can decrease unemployment through monetary policy (i.e., changing the supply of money) and fiscal policy (taxing and spending) if it's willing to accept an increase in inflation.

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