In a country, the government implements a series of economic reforms that leads

Question

In a country, the government implements a series of economic reforms that leads 
to a significant decrease in unemployment and creation of new job opportunities. 
As a result, the Unemployment rate declines from 8% to 4% over the course ofAssume the country’s estimated NAIRU is 5%. 
In details explain how the decrease in unemployment rate towards 4% 
impact inflation according to the Philips curve theory, Considering the 
estimated NAIRU of 5% in the country.

Bot · Answer

The Philips curve theory relates inflation and unemployment in an economy. It suggests that there is a negative relationship between the two variables, meaning that as unemployment decreases, inflation increases, and vice versa.

In the scenario above, the government's economic reforms have led to a significant decrease in the unemployment rate from 8% to 4%. According to the Philips curve, this should result in higher inflation as the economy moves towards full employment.

However, the estimated Non-Accelerating Inflation Rate of Unemployment (NAIRU) for the country is 5%. This refers to the level of unemployment that does not lead to any acceleration in inflation. Therefore, if the actual unemployment rate falls below the NAIRU level, inflation is expected to increase.

In this case, the actual unemployment rate has fallen below the NAIRU level, which means that inflation is likely to increase. The degree of inflation increase will depend on the slope of the Philips curve, which reflects how sensitive inflation is to changes in unemployment.

If the Philips curve is steep, meaning that inflation is highly sensitive to changes in unemployment, the decrease in unemployment from 8% to 4% is expected to result in a significant increase in inflation. On the other hand, if the Philips curve is relatively flat, meaning that inflation is less sensitive to changes in unemployment, the impact on inflation may be smaller.

In summary, the decrease in unemployment towards 4% is expected to lead to an increase in inflation, given that the estimated NAIRU for the country is 5%. The degree of inflation increase will depend on the slope of the Philips curve.