In the short-run, the relationship between unemployment and inflation is inverse. This means that the change in one will have the opposite effect on the other. So here, a fiscal policy aimed at reducing unemployment will increase the interest rate. For example, if Bartavia decides to lower taxes to increase consumption thru use of consumer’s marginal propensity to consume, and the economy in general thru the multiplier effect, it will increase the aggregate demand for goods and services. Marginal propensity to consume is the idea that that consumers will spend more money if they have more, but increases in income do not lead to equal increases in consumption because people save some of the money.
The additional income allows people to spend more causing more demand. Businesses may respond to this rising demand by raising prices because they know they cannot produce enough. In order to stop inflation, the central bank uses a restrictive monetary policy. This is where interest rates are raised and the bank sells its holdings of treasures and other bonds. The reduction in the money supply restricts liquidity and slows down economic growth.
From nominal and real rates there are also lowered and raised rates. When the interest rate is lowered consumer spending grows while savings decrease. Spending on items such as housing becomes one of the ways the AD rises. Though AD rises it pulls the economy out lack of spending, but puts the economy into the possibility of inflation. Differentiating from low rates, high rates stop inflation but creates the possibility of recession.
Lower taxes will increase consumers spending because they have more disposable income. This will worsen the govt budget deficit. The other method is Deflationary fiscal policy this involves decreasing AD therefore the government will cut their spending and or increase taxes. Higher taxes will reduce consumer spending. This will lead to an improvement in the government’s budget deficit.
Those who are in debt end up in worst conditions because the demands of goods and services fall. This results in further depression of unemployment and a vortex of problems. The effects of deflation are much more unpredictable than inflation and often come as a surprise (text, Ch. 12-2h). On the surface level, deflation may be seen as a positive considering the decreased price levels, but it will result in a depression of problems for those in debt.
Inflation can lead to unemployment, as people demand less due to higher prices and therefore demand for labor maybe decreased. Inflation also creates uncertainty for entrepreneurs, cost curves increase and revenue can decrease thus squeezing profits. Also when inflation is in the mind of the entrepreneur it can escalate easily as they will take inflationary actions like automatically increase prices and therefore it is imperative government spending/borrowing is controlled. Although government borrowing does increase the money supply, the monetarist view of a direct link between money supply and inflation is wrong, as proved when Britain experienced recession under Margaret Thatcher. In order to control the money supply the government cut borrowing and spending, which in theory would reduce the money supply, inflation and unemployment but interest rates had to rise to stop consumer borrowing, which in turn increased the exchange rate.
This will decrease the money supply because banks are not able to lend out as much money to customers. Conversely, if the required ratio decreases banks are required to hold a lesser amount of money in reserve therefore increasing the money supply because banks can lend out mo... ... middle of paper ... ...up. Inflation and GDP are directly related to each other however, a strategic combination of the macroeconomic tools could allow the Fed to control inflation with out affecting GDP, if it is within acceptable limits. When inflation is too high the economy is at risk of crashing because the value of currency is too low. Conclusion Unemployment is inversely related to changes in GDP.
Each countries actions and policy implementations resulted each a different conclusion. Deflation is when the price level of general goods and services start to fall. At this point, the inflation rate at the economy will be a negative amount, as it has fallen below zero. This falling price level may seem like a positive thing as it technically increases the monetary value of the currency, and that means the currency goes further, but the negative effects outweigh this. The effects of deflation can lead to a higher unemployment rate, an increase in the value of debt, lower capital investments and an obscured customer demand.
Due to inflation price level rises, purchasing power of general public goes down. When aggregate demand decreases supply less accordingly. Role of inflation in economy is negative overall. If producer produce less then employment opportunity may also goes down. Budget constraint of public may also shrink more then in order to tackle this problem then govt print excess supply of notes / money and when any extra money is created in economy It will increases the buying power of people .
In this sense, inflation is a monetary phenomenon. But what effect does inflation have on the economy and on investment in particular? Inflation causes many distortions in the economy. It hurts people who are retired and living on a fixed income. When prices rise these consumers cannot buy as much as they could previously.