Positive Effects of Inflation and Unemployment Rate

Positive Effects of Inflation and Unemployment Rate

Several factors can lead to the dwindling of an economy. Examples of such factors are inflation, unemployment, exchange rates, balance of payments and increased deficits. This is best seen through a business cycle, as there are economic booms, downturns and instances of economic recession. The measure of the production of an economy is best seen from the total amount produced. This is referred to as the Gross Domestic Produce (GDP). Soaring unemployment rates and increased inflation often have negative implications on any economy. However, some of these factors may have positive influences and effects to the economy.

The general increase in commodity and service pricing over several years has several benefits. For example, the Mundell–Tobin effect where a moderate increase in inflation would lead to increased investments in the economy. Lack of money in circulation would lead to increased hoarding by those with money. As a result, the lending institutions may be forced to lower their interest rates because of increased borrowing. Inflation usually reduces the purchasing power of currency. The same denomination of money purchases fewer commodities than it initially did. This acts as an incentive to invest the money before it continues to lose value. Instead of people hoarding their assets as liquidated money, they opt to invest in non-monetary capital projects.

At this point, it is noted that the returns of monetary assets, are lower than real assets. This avoidance of inflation leads to a positive effect on the economy. It is through investment in physical viable projects that the return of investment is higher than that of monetary assets. In turn, the steady state level of income is attained. The hypotheses imply that, in times of moderate inflation, there may be a general increase in the Gross Domestic Product within a certain period that could be attributed to the investments made in the long-term physical ventures.

Another positive implication is the creation of room to maneuver by leading financial institutions. Central banks have the capacity to readjust the discount rate depending on the level of the crisis, though this is mostly used to mitigate recession. The nominal rates are adjusted in order to be highly accommodative to borrowing of other banks from the central bank. Therefore, the frequency of money supply is controlled through buying and selling of goods to the public. This is done in order to manipulate interest rate for the implementation of a policy. For example, the money base is increased to facilitate the sudden increase in short-run interest, in the market. This helps regulate the rates for monetary policy implementation.


Wage outcome is dependant on the level of inflation. As the inflation levels increase, the nominal wages reduce. Inflation levels thus determine the benchmark of wage negotiations. Refusal of wage cuts during an economic downturn consequently means that, employers will reduce staff. This leads to high unemployment levels throughout the country. From the figure above, the 2000s when, high unemployment rates and high inflation were imminent.   It is for this reason that, wage flexibility is a hugely crucial principle during tough economic times. As witnessed in 2007-2008. This is unlike the incidences of the early 1990s, where the reverse occurred. This was the period when the economy was experiencing positive growth.

Maintaining of nominal wages helps in cushioning the drawbacks that arise from inflation and as such, labor markets attain equilibrium faster. It leads to increased discipline among people since they are forced to implement budget cuts and limit themselves from accessing loans because of the increased interest rates developed by the banks. When inflation is high, for instance, the value of long-term bonds rapidly decreases, therefore, reducing profitability margins.

Unemployment is in a way advantageous to the economy. It is caused by varied reasons and can be classified in different categories. Cynical unemployment is caused by changes that have occurred in the business cycle. Frictional unemployment occurs when people are moving between jobs. It is seen as a transition period when an employee is seeking another job. Technological unemployment is caused by automation. In this case, workers are replaced by technologically advanced machines that operate fast and are increasingly efficient. Seasonal unemployment happens when there is no work because of the seasons. For example, lifeguards lacking work during winter ‘off seasons’ (O’Connor 2000).



Figure 2 unemployment rate between the years 1980-2012


Unemployment in the market place would mean high productivity in the marketplace as those already working would not want to risk losing their jobs. Technological unemployment, which is caused by advancements in technologies, leads to automation of systems. Therefore, fewer personnel shall be employed to work as the automated machines give more work output and have higher accuracy levels. From the fig.2 above, in the 1980s there was technological unemployment. During this period there was economic growth as those employed worked diligently and were aided with the automation of more machines. In the 2000 decade, employment levels were in the rise but it was during this time that there was the great economic depression.

Some of this high unemployment rate can possibly be attributed to the efficiency wage. It is this concept that the Sharipo and Siglitz model was based on. Efficiency wage is based on the premise that employers pay their employees more than is required to enhance their productivity and efficiency. Through this, it is believed that there is a reduction of costs that is experienced Cutting down on cost leads to saving of money resources and even energy. The greater effect of this is that it may help in turning the economy upside down. Though this, the efficiency wage has its advantages. It may also have some loopholes as minimum wages can be used as a counteractive method. Setting of a minimum wage affects the efficiency wage theory.

Obtained from macroeconomics, the Phillips curve was used to depict visually, the inverse relationship between the rate of inflation and the rate of unemployment (Sexton, 2002). It implies that the rate of unemployment and inflation in the economy are correlated. An existing premise suggests that there is a clear negative relation between unemployment and the cyclical components of inflation. The theory suggests that, growth in the economy leads to the increase in inflation. Consequently, the rise of inflation leads to more job opportunities but less employment. An optimal level in the curve influences the growth of the economy.

Usually the unemployment outcome is caused by the attempt of the government to influence the preference functions of an economy. This preference function is influenced by the Phillips curve, which measures disutility (Arestis et al, 2007). Therefore, the indifference curve closest to the origin is preferred.


















Arestis, P., Baddeley, M., & McCombie, J. S. L. (2007). Economic growth: New directions in theory and policy. Cheltenham, UK: Edward Elgar.

Bureau of Labor Statistics (2012) Labor Force Statistics from the Current Population Survey Retrieved from http://data.bls.gov/generated_files/graphics/latest_numbers_LNU04000000_1980_2013_Annual%2BData_data.gif


O’Connor, D. E., & Faille, C. C. (2000). Basic Economic Principles: A guide for students. Westport, Conn: Greenwood Press.

Sexton, R. L. (2002). Exploring economics. Mason, Ohio: South-Western/Thomson Learning.





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