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How Can Low Unemployment Gradually Increase Inflation

Updated : September 29th, 2020

The trade-off between inflation and unemployment

The trade-off between inflation and unemployment was first reported by A. W. Phillips in 1958—and so has been christened the Phillips curve. The simple intuition behind this trade-off is that as unemployment falls, workers are empowered to push for higher wages.

Firms try to pass these higher wage costs to consumers, resulting in higher prices and an inflationary build up in the economy. The trade-off suggested by the Phillips curve implies that policymakers can target low inflation rates or low unemployment, but not both. During the 1960s, monetarists emphasized price stability (low inflation), while Keynesians more often emphasized job creation.

Relation between inflation and unemployment
Striking Inflation

Stagflation in the 1970s

The experience of so-called stagflation in the 1970s, with simultaneously high rates of both inflation and unemployment, began to discredit the idea of a stable trade-off between the two. In place of the Phillips curve, many economists began to posit a “natural rate of unemployment”. If unemployment were to fall below this “natural” rate, however slightly, inflation would begin to accelerate.

Under the “natural rate of unemployment “theory (also called the Non-Accelerating Inflation Rate of Unemployment, or NAIRU), instead of choosing between higher unemployment and higher inflation, policymakers were told to focus on ensuring that the economy remained at its “natural” rate: the challenge was to accurately estimate its level and to steer the economy toward growth rates that maintain price stability, no matter what the corresponding level of unemployment.

Pros and Cons of the NAIRU Effect

The NAIRU has been extremely difficult to pin down in practice. Not only are estimates of it notoriously imprecise, the rate itself evidently changes over time. In the United States, estimates of the NAIRU rose from about 4.4% in the 1960s, to 6.2% in the 1970s, and further to 7.2% in the 1980s. This trend reversed itself in the 1990s, as officially reported unemployment fell. In the latter half of the 1990s, U.S. inflation remained nearly dormant at around 3%, while unemployment fell to around 4.6%. In the later Clinton years many economists warned that if unemployment was brought any lower, inflationary pressures might spin out of control. But growth in these years did not spill over into accelerating inflation.

Depicting the inverse relation between inflation and unemployment through the Phillips Curve

The early idea for the Phillips curve was proposed in 1958 by economist A.W. Phillips. In his original paper, Phillips tracked wage changes and unemployment changes in Great Britain from 1861 to 1957, and found that there was a stable, inverse relationship between wages and unemployment. This correlation between wage changes and unemployment seemed to hold for Great Britain and for other industrial countries. In 1960, economists Paul Samuelson and Robert Solow expanded this work to reflect the relationship between inflation and unemployment. Because wages are the largest components of prices, inflation (rather than wage changes) could be inversely linked to unemployment.

The theory of the Phillips curve seemed stable and predictable. Data from the 1960’s modeled the trade-off between unemployment and inflation fairly well. The Phillips curve offered potential economic policy outcomes: fiscal and monetary policy could be used to achieve full employment at the cost of higher price levels, or to lower inflation at the cost of lowered employment. However, when governments attempted to use the Phillips curve to control unemployment and inflation, the relationship fell apart. Data from the 1970’s and onward did not follow the trend of the classic Phillips curve. For many years, both the rate of inflation and the rate of unemployment were higher than the Phillips curve would have predicted, a phenomenon known as “stagflation.” Ultimately, the Phillips curve was proved to be unstable, and therefore, not usable for policy purposes.

Monetarists’ Rebuttal

The 1960s provided compelling proof of the validity of the Phillips Curve, i.e. that a lower unemployment rate could be maintained indefinitely as long as a higher inflation rate could be tolerated. However, in the late 1960s, a group of economists who were staunch monetarists, led by Milton Friedman and Edmund Phelps, argued that the Phillips Curve does not apply over the long term. Their contention was that over the long run, the economy tends to revert to the natural rate of unemployment as it adjusts to any rate of inflation.

Consider a scenario in which the natural rate of unemployment is prevalent. (The natural rate* is the long-term unemployment rate that is observed once the effect of short-term cyclical factors has dissipated, and wages have adjusted to a level where supply and demand in the labor market are balanced). If workers expect prices to rise, they will demand higher wages so that their real (inflation-adjusted) wages are constant.

Now, if monetary or fiscal policies are adopted to lower unemployment below the natural rate, the resultant increase in demand will encourage firms and producers to raise prices even faster. As inflation accelerates, workers may supply labor in the short term because of higher wages — leading to a decline in the unemployment rate — but over a longer term, when they are fully aware of the loss of their purchasing power in an inflationary environment, their willingness to supply labor diminishes and the unemployment rate rises to the natural rate. However, wage inflation and general price inflation continue to rise.

Over longer periods, higher inflation would not benefit the economy through a lower rate of unemployment; by the same token, a lower rate of inflation should not inflict a cost on the economy through a higher rate of unemployment. Since inflation has no impact on the unemployment rate in the long term, the long-run Phillips curve morphs into a vertical line at the natural rate of unemployment. Friedman and Phelps’ findings gave rise to the distinction between the short-run and long-run Phillips curves. The short-run Phillips curve includes expected inflation as a determinant of the current rate of inflation and hence is known by the formidable moniker “expectations-augmented Phillips Curve.”

(* Note that the natural rate of unemployment is not a static number but changes over time due to the influence of a number of factors. These include:

  • The impact of technology,
  • Changes in minimum wages,
  1. The degree of unionization.

In the U.S., the natural rate of unemployment was at 5.3% in 1949, rose steadily until it peaked at 6.3% in 1978-79, and declined thereafter; it is expected to be at 4.8% for a decade starting from 2016).

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  1. I had trouble getting my proof of self-employment to upload in secure file exchange and finally got it submitted by 12:06 am , 6 minutes late. What are the possibilities that they will deny it? I have received unemployment from March 2020 to some of Jan and some in Feb 2021. Most of Dec, Jan, Feb, March, & april were stopped for this proof of employment.
    Also, I see proof of Income as a 2nd issue but it is always on there. That was not on my TO DO list.
    I feel for u all on ID.ME…

    Anyone trying to reach UI, call their number, press 2 or 3 (questions abt filing a claim?) and then wait thru the message. At the end of it, u will be connected to a live person! I promise.. don’t push another button.. I’ve done it 4 times and it never failed.

    We lost our home, my ex took my child…. (kept her after a visit and called cps facilitating drama while the cops wouldn’t give her back without paperwork locked up in the court house..shut down for covid) I raised her by myself for 12 years & now she is with a violent alcoholic and parental alienating parent .. ….my dog, my 9-year sweet little best friend, was attacked, passing away 3 days later.. all in this time frame.
    But! It will all be ok. I have faith.

    Be grateful for your life and all that is in it today. What u dwell on daily will be your strength or weakness.
    Good luck to all of u.
    And thank you, Jeff, for responding out here. It is appreciated!
    Davulia S.

  2. I filed over two months ago. I have not received any information. My status says “pending resolution”. I have no way of contacting anyone. My position was eliminated at my job and I submitted the documentations online. I dont know what else I can do.

  3. I have been apply Ohio Pua unemployment since July 5th still pending issues. Upload what they ask for when ever I call says your case is in Adjudication. Very very frustrated, financially I am broke. Health issues. Waiting a long period.Don’t know what I will do ?

    1. Nafisa,

      I can understand your situation. There will be a delay considering the number of applications that are being processed. Please continue chasing the office/check your status online at regular intervals until payments normalize.

    2. Same here since Feb 2021 turned in all the documents still pending issues 3 months now. When you call they tell you to be patient. Pulling my hair out it’s so frustrating.

  4. I was receiving PUA unemployment. they made me file for a new claim in February. Now I am in adjudication even though I gave all the same information from my previous claim. Have been adjudication since February and I call and they say they will put in a ticket to have an Adjudicator call me. Nothing. I am wondering If I can go down to to Maryland Unemployment Office and demand that someone talk with me to release my claim for payment. It’s been 56 days. I read that they have a maximum of 45 days.

    1. Luis,

      Your adjudicator may be inundated with pending cases. Please continue to follow up (if you have the contact details) or consider the option of visiting an office in the vicinity if safe and feasible.

    2. t sounds just like mine only im disqualified yet actie every till sept 4th . they haven’t asked me for anything! i file then its disqualified yet im told im ok and have nothing to do bit wait for an answer? answer to what? they switched my program and all and asked me to provide proof for a claim that wa denied al eady back in 2018! deny me once and then again perhaps? lol idk

  5. My mom had unemployment in Florida. She just recently moved temporally to California with a sister since she needs assistance, and now the website is telling her she cannot do anything because she is register in another state. Can she keep filing unemployment in Florida, even if she is living and register now in another state? how is the process to change the unemployment? I tried calling and there is no answer. Thank you!

    1. Stephanie,

      Please ask your mother to consider transferring the UI benefits from FL to CA (details will be available on either of the websites). If there are benefits weeks left in the account, she will be able to claim them.

    1. Leatha,

      UI benefits are offered to claimants who lose employment involuntarily and be able to and available for work.

  6. I lived in ga in 2019 and move to florida in 2020 and work for the xmas months in nov-dec. I was told to do a combine wage claim. my question is which state do i file the claim in?

  7. I filed for pua in Ohio back in October 2020.My claim has been in ajudacatuon since 11/1/20.So 2 to 6 weeks is a total understatement! When I call.i am told to basically hurry up and wait some more.I have recently been redetermined and my claim is allowed.but I have one pending issue.How long is too long?

    1. Nicole,

      Unfortunately, nobody has an answer. There are perhaps thousands of pending applications. Please consider the option of visiting an office in the vicinity if safe and feasible.

  8. If you claim your weeks for unemployment and for the next 2 months you still have not received your money. Where can you go in volusia county to talk with a live person

      1. HI Jeff,
        I applied back in Dec 5th, 2020 and I haven’t received any correspondence, is there a local office that I can make an appt to make certain my claim is right.

        1. Adam,

          You can consider visiting an office in the vicinity if safe and feasible (details will be available on the Unemployment Office’s website).

  9. On NYS DOL website, my claim is saying current yet the information is for my old claim with 0 days remaining despite receiving 2 weeks of payments on the new claim and I was able to certify last night. I haven’t received anything; no letters or emails.

  10. I was disqualified for UI benefits for not providing an ID and other forms of identification. How do I fix this?

        1. Gary,

          You may not be eligible since unemployment insurance is only extended to those who become unemployed due to involuntary reasons.

    1. Hi Mike, I’m in NYS and was at the end of my BYE on 3/14, I was still certifying but wasn’t getting paid. I found out I had to file a new claim because my other was exhausted. I’m still waiting on approval. Maybe you have to file a new claim. I hope this helps.

  11. They say 2-6 weeks it’s more accurate to say 2-6 months; and when you call many of them are rude and unwilling to assist!

  12. someone needs to look into Sharon L. Anton gillette, wyo. or dickinson, nd she is a fraud and has done so many fraudulent things and please look into her

    1. Annette,

      Please report it to the Fraud Division of the Unemployment Office in your state. You can report on the website.

  13. I worked part time for thee years here in florida. I’m currently not working. I’m also retired and collects social security.
    My question is
    Am I qualified to file for unemployment ?

    1. Ruby,

      To be eligible, you’re required to have sufficient hours and earnings. Please use the “Benefits Calculator” available on this website.

  14. So adjudication takes 8 to 12 weeks. Oh okay, that explains why I havent received payment since July. That surely helps just like the rest of the information that you give. And by the way. What’s the NEW reason you can’t get through to the Call Center.

    1. Maria,
      I have gotten through to the call center (live agent) every time i’ve tried calling within the last 2 weeks. The number to a live agent (follow the prompts carefully) is (667)-207-6520. i have gotten through within 10 to 15 mins with each call i had made!

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