Inflation and Unemployment

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Inflation is the rise in general prices of goods and services over a specific period of time. Unemployment is a state where people are able and willing to work at the ongoing market prices of labour but they are unable to secure a job. According to the Phillips curve, there is a consistent relationship between inflation and unemployment (Nevile, J. W. 1981, pg 3). When the rate of unemployment is low, the level of inflation is high and when the level of employment is high, inflation level is low. Since majority of the Americans regard inflation to be a bigger threat than unemployment, they will rather stay unemployed but to let the value of a dollar stabilize. Therefore they will rather be employed during stable prices than rising prices.
The Americans favor unemployment to inflation. When 10% of the workers are laid off, it will imply that unemployment will increase and an increase in unemployment implies a decrease in inflation. If the wages are reduced by 5%, it will mean that even more worker can be employed due to the reduction of labour cost. This will lead to an increase in employment thus the level of unemployment will go down. A decrease in unemployment leads to an increase in level of inflation. Therefore they will rather go for 10% of workers being laid off than a 5% cut in their wages. They will vote for 10% workers being laid off. Their knowledge of who will be laid off won’t affect their decision in voting because they are all against inflation. They will rather not work than work for a wage with low purchasing power. Therefore they are after their purchasing power than just a job.
Fiscal policy is an attempt to manipulate government expenditure and taxation so as to affect aggregate demand and aggregate supply to achieve full employment and price stability. Monetary policy is a policy that affects money growth (Langdana, F. K. 2009, pg 34). Therefore when the government uses monetary policy, the money supply will increase. The government will cut taxes to treat the deficit.
When the Fed will prevent growth in reserves, it implies that the borrowing will be constant thus no preventions on borrowing from commercial banks. This will result to an increase in money supply as the government too is borrowing.
According to the LM curve, when the two policies are used, at the point where the interest rate is low, monetary policy has no power. When fiscal policy is used, increase in supply of money has no effect on the interest rate. Therefore when the IS-LM equilibrium is low, fiscal policy is the suitable policy to use.
When the Fed increase the supply of loanable funds through and expansion of commercial banks, the supply of money will increase at the same ongoing interest rate. The Fed will not succeed to prevent the interest rates from rising. Interest rate is assumed to be flexible according to the classical economists. This implies that the interest rate will rise in order to attain the previous equilibrium. Therefore a lower interest rate will lead to more money in the economy leading to inflation. At the point of liquidity trap as advocated by the Keynesian economist is where inflation will be set.
When the economic resources are idle, the output is always low. The reason the government will borrow will be to stimulate the economy. Therefore most of these idle companies will demand for more money in order to increase their productivity through effective utilization of resources. Thus the demand of money will increase increasing the cost of borrowing which in other words are the interest rates.

References:
Nevile, J. W. (1981). Is the short run Phillips curve still relevant for policy decisions?. Univ of NSW.
Langdana, F. K. (2009). Macroeconomic policy: Demystifying monetary and fiscal policy. New York: Springer.

References: Nevile, J. W. (1981). Is the short run Phillips curve still relevant for policy decisions?. Univ of NSW. Langdana, F. K. (2009). Macroeconomic policy: Demystifying monetary and fiscal policy. New York: Springer.