RELATION BETWEEN INFLATION AND UNEMPLOYENT

1. PHILIPS CURVE:
The negative correlation between the inflation rate and the
unemployment rate is known as the Philips curve. The curve implies that
an economy faces a trade-off between inflation and unemployment.

2. Suppose for instance that the unemployment rate is 4% and that the
inflation rate is 3% as at point a in the figure. The Philips curve implies
that the government could pursue expansionary policies that would move
the economy to point b, where the unemployment rate falls from 4% to
2% and the inflation rate rises from 3% to 6%. Depending on what the
government perceives to be in the national interest, it might then be
worthwhile to pursue fiscal and monetary policies that would lower the
unemployment rate at the cost of a higher rate of inflation.