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UNIVERSITY OF THE PUNJAB

DEPARTMENT OF ECONOMICS

Group no 5
Maimuna Alauddin RBS 04
Sheher Bano RBS 05
Subhan Allah RBS 10

Program: BS-Economics (Replica)


Submitted to: Sir Khalid Mehmood
RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT IN
PAKISTAN

Maimuna Alauddin

Sheher bano and Subhan Allah

Department of Economics, University of the Punjab

E-mail: maimunaalauddin@outlook.com

ABSTRACT

Unemployment and inflation are issues that are central to economic life of every
developing country. This paper estimates the relationship between Inflation and
Unemployment for Pakistan economy over the period 1991-2017, in order to know
whether there is a relationship between inflation and unemployment. Analysis is
based on simple linear regression with unemployment as a dependent variable and
inflation as an independent variable. The research outcome showed that it is null
hypothesis and there is no statistically significant relationship between inflation
and unemployment.

KEYWORDS

Unemployment and Inflation

INTRODUCTION

Unemployment and Inflation are one of the most important


macroeconomic issues. A.W Phillips was the first one who related the rate of
inflation and the rate of unemployment in the early 1960’s. He proposed a negative
relationship between Inflation and Unemployment which he called Phillips Curve.
The later studies identified that there is a relationship between both the variables in
the short run but in the long run they are unrelated.

Unemployment is a macroeconomic problem that affects common


people. When the people want jobs and they don’t get, even after searching it is what
we call unemployment. It occurs when there are fewer jobs and the required demand
of jobs is high. When a person don’t have a job, his family is affected that is how
when many people don’t get earning ultimately the whole nation has to suffer, they
wouldn’t be able to produce and there would be no consumption. A countries
Unemployment is calculated by dividing the number of unemployed people with the
number of people who are employed. There are many types of Unemployment which
include Frictional Unemployment, Cyclical Unemployment, Structural
unemployment etc.
Frictional Unemployment is when a people leave their existing jobs to find a better
one.
Cyclical Unemployment is when there is not enough aggregate demand for workers.
Structural Unemployment occurs when the required skills and experience is not
available and the already employed ones loses their job because their skills are
outdated.
Inflation is a proportion of the rate at which the general price level of a
basket of chosen goods and services in an economy increases over a period of time.
It is the constant rise in the general level of prices where a unit of currency buys less
than it did in prior periods. Inflation shows a reduction in the buying intensity of a
country's money. As prices rise, a single unit of cash loses an incentive as it
purchases less goods and services. This loss of purchasing power impacts the general
cost for basic items for the common public which ultimately prompts a delay in
economic growth.
Inflation can be seen positively or negatively. People with tangible assets, similar to
property or supplied commodities, may get a chance to see some inflation as that
raises the value of their benefits. People holding cash may dislike inflation, as it
erodes the value of their cash holding.

Unemployment and inflation are issues that are central to both the social
and economic life of every country. A.W Philips initiated the idea of a trade-off
between inflation and unemployment and showed evidence of a negative
relationship between the unemployment rate and the changes in nominal wages for
British data. It was later used by the economists as inflation- unemployment trade-
off. Many theoretical and empirical studies have been done on the Phillips curve.
When we talk about our own country Pakistan a tradeoff has been seen between
inflation and unemployment in short run by using latest version of empirical study
of Phillips curve . High economic growth, price stability and low unemployment are
the most enviable macroeconomic goals(Afzal and Awais). Inflation is regarded as
a problem when the inflation rate is too high and rising. Unemployment results from
lack of employment opportunities and is a permanent feature of the economy.
Inflation and unemployment are major economic problems which must be seriously
addressed.

LITERATURE REVIEW

Phillips Curve is named after William Phillips who relates the rate of
unemployment and the rate of change of money wage rates in the United
Kingdom(1861-1957). He assumed that when unemployment is high that is
demand for labor is less than supply, labor accept to work in low wage rates
but when unemployment is low that is demand is more than the supply, labor
demand high wage rates. Another factor that effects wage rates is the change
of unemployment. When demand for labor increases unemployment decreases.
As wages are a major input cost for companies, increase in wages will lead
to higher prices of products and services in an economy , which ultimately
push the overall inflation rate higher. That is why Phillips traced the relationship
between inflation and unemployment rather than money wage rates. Phillips
did not state himself that there is any relation between inflation and
unemployment. But his idea was later discussed in detail through his statistical
findings. Samuelson and Solow in 1960s were the first who pointed out the features
of the curve namely, that the unemployment and inflation rate could be lowered with
a small rise in inflation and played an important role in the Great Inflation that
occurred in the US during the 1960s and 1970s. Friedman and Phelps argued that
there is no trade-off between unemployment and Inflation in the long run. In the long
run, a higher or lower inflation rate has no effect on the unemployment rate because
the unemployment rate is always equal to the natural rate in the long run.
Enormous number of analysts have conducted research on this point; trade-off
between inflation and unemployment. A few of those creators and
their researches are specified in this paper. Liu and Jansen (2010) they had
contended that the basic concept of traditional Phillips curve model holds that there’s
a tradeoff between inflation and real action (unemployment), in this manner it is still
used to estimate expansion. Berger(2010), they discover that increase
in cyclical unemployment will lead to decrease in yield which ultimately causes to
decrease in inflation. Michaelk also supported the tradeoff between unemployment
and price shocks. They also suggested that monetary policy does not affect
unemployment rate other than price shocks. Bitros and Panas (2006), Christopoulos
and Tsionas (2005), they argued that, there is unidirectional tradeoff between short-
run inflation and total factor productivity. In the long-run there is bi-directional
relation. Antonio (2006), argued that when a country’s economic system faces
recessions (downturns), Inflation and unemployment go in conflicting directions.
And when the economy is smooth and prospers it proves the positive relations, both
move in same direction, they don’t go in a conflicting directions. N. Gregory
Mankiw, said, short run tradeoff between inflation and unemployment still exist in
economics, because all economists are agreed that monetary policy affect
unemployment in short run and also estimates the inflation in long run.

Karanassou & Sala (2010) argued there's a tradeoff between inflation and
unemployment in long run since of money and productivity development which
leads to diminish in unemployment, whereas supply shocks like oil prices which
lead to extend in unemployment. Within case of 1970 monetary extension driven
to extend in inflation and reduced the unemployment which was very slow down in
efficiency , determined the extend in inflation and unemployment.
He contended that increase in efficiency development causes decrease in
inflation and also decrease in unemployment. Hussein Ali Al-Zeaud
(2011) contended that there's no tradeoff between inflation and unemployment in
Jordan economy between 1984 and 2011 since outside labor were not included in
the unemployment rate calculation. He utilized Granger-Causality test to check
relationship between variables and the heading of causation and techniques depends
on testing stationary, integration, co-integration as per-requisite.

RESEARCH QUESTION

What is the relationship between inflation and unemployment?

OBJECTIVE

The object of the research is to find out the relationship between inflation and
unemployment.
RESEARCH HYPOTHESIS

Research hypothesis is null hypothesis. There is no statistically significant


relationship between inflation and unemployment.

RESEARCH DESIGN AND METHOD

Secondary data was used for this research. Data was sourced from the
global economy of Pakistan. The population size was 1947 to 2018 and the sample
size we took was 1991 to 2017. We compared both the variables Inflation(INF) and
Unemployment(UNEMP).

The statistical method that is Simple linear regression was used to study
the relationship between inflation and unemployment. In the first model Inflation
was regressed on unemployment; in order to ascertain the impact of explanatory
variable on response variable. In the second model unemployment was regressed on
inflation.

RESULT AND DISCUSSION

Linear regression models are used to show or predict the relationship between
two variables or factors. The factor that is being predicted (the factor that the
equation solves for) is called the dependent variable. The factors that are used to
predict the value of the dependent variable are called the independent variables. The
regression model that is simple linear regression model is applied for studying the
relationship between Inflation and Unemployment by taking unemployment as a
dependent variable and inflation as an independent variable.
Coefficients

Unstandardized Standardized
Coefficients Coefficients
Std.
Model B Error Beta t Sig.
1 (Constant) 6.373 .876 7.278 .000
Inflation rate of Pakistan
-.164 .093 -.333 -1.765 .090

a. Dependent Variable: Unemployment rate of Pakistan

After applying the simple linear regression test, Null hypothesis (Ho) is accepted
that is there is no relationship between inflation and unemployment in Pakistan. The
value of significance must be 0.05 to get the null hypothesis rejected but after
applying regression test to data the value of significance is 0.09 and the value of
t-test is -0.333. From this regression result, the coefficient of inflation is negative,
this is showing that relationship does not exists between inflation and
unemployment. Therefore we conclude that there is no relationship between the two
variables in Pakistan.

CONCLUSION

Unemployment and Inflation are one of the most important macroeconomic issues.
Inflation is regarded as a problem when the inflation rate is too high and rising.
Unemployment results from lack of employment opportunities and is a permanent
feature of the economy. Studies carried out by most economists revealed that in the
quest to reduce unemployment, rising inflation may be risked. A. W. Phillips
research work (1958) attested to this fact of tradeoff relationship. However, some
other economists led by Milton Friedman challenged the trade-off relationship
thesis, saying that it exists only in the short-run, that in the long run, the Phillips
curve is vertical without any sign of trade-off relationship. This paper estimates the
relationship between Inflation and Unemployment for Pakistan economy over the
period 1991-2017, in order to know whether there is a relationship between
inflation and unemployment. The research outcome showed that there is no
statistically significant relationship between inflation and unemployment in
Pakistan. But they are major economic problems which must be seriously addressed.

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Friedman, Milton (1968), The Role of Monetary Policy, American Economic


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