How Would You Explain A Simultaneous Rise In Unemployment And Prices In An Economy?

2598 words - 11 pages

Controlling the level of inflation and achieving close to full employment are both major macroeconomic policy objectives which governments try to achieve. Stagflation is a period when there is a persistent rise in prices and slow economic growth. Slow economic growth implies that there is a rise in unemployment as the economy is not working at its full potential. As part of their objectives, governments aim to lower unemployment and try to keep prices stable but when there is stagflation, conflicts tend to occur as policies intending to lower inflation can cause output to fall further. This essay will evaluate the causes of such an occurrence happening and what governments can do to resolve ...view middle of the document...

3%. These figures highlight the two problems of high inflation and unemployment that were being faced by the government. The oil price shock of the 1970’s led to a considerable rise in inflation as the price of oil increased costs for firms. Industries such as the motor industry began to slump leading to a fall in output and many un-skilled labourers left without a job. There are now current fears that the UK may soon be experiencing a period of stagflation due to the similarities of the stagflation in the 1970’s.

The price of petrol reaching record highs - prices increasing by about 15p per litre in one year (Chapman, 2011) - are contributing to the increasing rate of inflation similar to what happened in the 1970’s. As well as this prices of cotton and wheat have soared recently due to the September 2010 floods in Pakistan – a large producer of cotton (The Independent, 2010). These increases in prices all contribute to cost-push inflation as business costs of production increase. This is represented in Graph 2. The shift from SRAS 1 to SRAS 2 (increase in cost) has made the price level in the economy increase from PL1 to PL2 as well as real national output to fall from Y1 to Y2. These rises in costs have threatened global economic recovery (Cohen, 2011) because of this loss in output.

In January 2011 unemployment in the UK was 2.53 million, 8% of the workforce, which implies worrying times for job seekers now and in years to come. When stagflation occurred in the 1970’s and unemployment began to rise this was due to the slump in manufacturing sectors in the British economy. Unemployment in the UK is currently so high due to the effects of the recession of 2007/2008. Increasing national debt since the recession has led governments to cut public sector jobs such as in health and education. The private sector is also struggling to recover as banks are not lending meaning companies cannot grow and invest. Investment (one of components of AD) has fallen (AD1 to AD2) which has lead to a fall in output (Y1-Y2) as shown in GRAPH 3.

Currently in the UK it can be argued that we may be falling into a period of stagflation – a very bad scenario for any economy. The Monetary Policy Committee (MPC) have kept interest rates at 0.5% a low level of interest since February 2009 to try and stimulate aggregate demand. A low level interest encourages consumers to spend rather than save and therefore consumption (a component of AD) increases. As well as using interest rates to stimulate AD the UK government have bought assets – government gilts and corporate bonds – to stimulate AD. This is known as quantitative easing, where the government injects money into the economy in hope to revive it. The money is injected into the circular flow of income and because of the multiplier effect the money is again circulated around causing AD to rise. Philip Shaw, chief economist at Investec, said that quantitative easing "should in principle encourage the banks to...

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