ECON 112-L52: The relationship between inflation and unemployment in Japan and China

Dr. Ashraf G. Eid
ECON 112-L52
1 April 2020

The relationship between inflation and unemployment in Japan and China
Relationships of unemployment and inflation variables in the economy were first advanced through the Keynesian model. The model stated that employment increase did not necessarily relate with an increase in levels of inflation, and only the intervention of the expansionary fiscal and monetary policies causes the relationship to exist since they only raise inflation levels in an economy (Mukher). Therefore, the model gives no trade-off or clash in the correlation between rising prices and unemployment. However, an article published by A.W. Philips in 1958 gave the term Philips curve in explaining the link between rising prices and unemployment in an economy. The Phillips curve theory relates the relation to nonlinear and inverse (Mukher). With knowledge from the approach, the study seeks to explain the association between rising prices and unemployment in Japan and China.

In China, the relationship is inversely related, confirming to the Phillips theory. The inverse relations regard that as one increases, the other must decrease. These trade-off in the economy tends to balance the adverse impacts of each variable in the economy (Mukher). China has recorded continuous growth in its economy over the past 30 years, with a growth rate of 10%. However, the growth has experienced numerous changes in the macroeconomic variables of the country (Li and Liu). The GDP growth increases the Consumer price index while the unemployment rates fall as the economy continues to grow factored by the rise in inflation.

The numerous statistical data analysis regarding the unemployment and inflation in China shows that the Chinese economy obeys the Phillips curve theory, whereby it states that the lesser the unemployment rate, the higher the rate of inflation (Mukher). Using data of China’s economy between 1978 and 2010, it exhibits negative relations in the unemployment and rise of the country both in the distant future and the near future of the economy. The data shows that when CPI, which is used as a measure if inflation rises by 1% while the unemployment falls by 0.74% (Li, and Liu). However, it is essential to acknowledge the connection of the two variables to the GDP of a country since high GDP lowers the unemployment rate while also increases the inflation rates in an economy.
However, in the Keynes perspective, China relates in that as the higher natural growth rate becomes experienced, it is hard for the government to deal with the issue of unemployment in regards to inflation levels (Li and Liu). This is because the decreasing actual unemployment rates cannot relate to the growth of the increasing population growth rate. Therefore, as Keynes suggested reaching a full employment situation is very hard. Thus, the relationship between inflation and unemployment does not exist since it can only work in a full-employment attained economy.
Also, Japan demonstrates a relationship between inflation and unemployment, similar to that advanced by Phillips. In a study investigating the economy, data shows that the economy of Japan also conforms to the Phillips curve and, even to some extent, provides support of the Keynesian model. In a 1970-2010 data analysis, the statistical analysis of the Philips curve shows that the curve has a slope of -1.77 (Kitov) relating to the changes caused by an increase in inflation, leading to the lowering of unemployment.

However, the CPI data brings uncertainty in explaining the relationship. Since in the long run and short run of the economy, the data variables change and do not tell the full employment attainment situation where with full employment, the increase in inflation has no significant change to the levels of unemployment in the economy (Kitov). The CPI omits many factors, and through this, they ascertain the aspects of Keynes in explaining the impact of the expansionary fiscal and monetary policies in describing the association between unemployment and rising prices (Mukher). The two variables rely on the labor force of a country, and these measures tend to influence the movement of the labor force, causing the desired outcomes in society. The statistical analysis through a linear regression provides a Philips curve of Japan as R^2= 0.68, also asserting the opposite correlation of rising prices and unemployment.
Consequently, the two nations provide insights into the connection between rising prices and unemployment through the Phillips curve. However, the different causes of data discrepancies in explaining some gaps in the data bring up the Keynesian model. In China, these levels are influenced by GDP increase. While also in Japan, they are influenced by the labor force of the country. Keynes suggested that an increase in unemployment cannot lead to a rise in inflation. By looking at the long-run effects of the two Keynesian models is true since the fiscal and monetary policies can regulate the inflation and unemployment levels of the country (Mukher). However, in the short run, the relationship is more interpreted using the Phillips curve. Which through it, the economist may learn how to respond to the differences in the two variables and create an equilibrium that is hard to maintain, providing the dilemma of either managing low inflation and increasing unemployment or lowering unemployment levels and rising inflation levels. Therefore economists must employ the two approaches among others in defining the relationship between inflation and unemployment.

Unemploymnet rate, Inflation Relationship Impact on Economy

1-Unemploymnet rate:
Unemployment is one of the Vital Indicators on the Health of an Economy, In Other Words it gives a measures How a Specific Economy is using and Utilizing the Human Resource/Capital , The Unemployment happens when an individual who is capable and willing to work is searching for a Job but fails to find work. . The most common measure of unemployment is the unemployment rate, which is the number of unemployed people divided by the number of people in the labour force – not the Population.
The base we relate to in the Unemploymnet Rates is not the Population of an Economy Labour, rather we use the Labour Force which includes all Employed individual , plus Unemployed Individuals who are in the working age, capable, able to work and searching for Jobs but couldn’t find a job yet – groups who are excluded from the Labour includes “but not limited to” Children, Disabled People , Medically not fit to work groups, Elderly People and those who are voluntary not looking for job although they might be in the working age and ability but decided not wok.

The Unemploymnet Rate is calculated as

Unemployment is considered a problem most societies and economics face , Governments try to solve the Unemployment to foster Economic growth and Social Stability
In Order to Fix and minimize the Unemployment “People Cant find Job”, we need to understand the Reason and Types of Unemployment

– Frictional Unemployment – The Number of Unemployed people due to moving or changing from one Job o another. For example, a school-leaver may take some time to get his first job.
– Structural Unemployment – The Number of Unemployed people due to occupational or geographical immobility’s. In Other Words Unemploymnet that arises due to a mismatch between Demand and Supply of Certain Jobs, Often occurs after structural change in the economy. E.g. closure of mines left many miners struggling to find suitable work.
– Seasonal Unemployment – The Number of Unemployed people due to available jobs created by specific season like summer but vanishes or disappears during winter (e.g. out of tourist season)
– Cyclical Unemployment – Unemployment due to Changes in the Business Cycle , Expansions or Contraction Phase , In Contraction phase of the Business Cycle, Aggregate Demand is low, Output is Low and Unemploymnet is High

2-Inflation

– Inflation is what is Known Best as the increase in the General Price Level of Products in the Economy, Having a stable low Inflation Level is one the main Targets on the Macroeconomic Level by Many Governments.
Continuous Hight Rise in the Prices of Goods and Services in the Economy “Hight Inflation” is considered undesirable because it distorts the ability of Both Business and consumer to proper plan, consume and invest as the future prices are very hard to Predict which leads to Economy production above capacity levels, this might lead to Sudden pop-out of the Inflationary phase followed by sharp decline. Output and Employment Level
Inflation Cause :Desirable Inflation is around 3%-5% to ensure Growth in Aggregate Demand, Output and Employment
Inflation is measured by the Increase in the Price Level, Several measures are used to calculate Inflation

1. The GDP Deflator: Nominal GDP by real GDP and multiplying by 100.

2. Consumer Price Index: CPI
Is and Index/ measure for changes in the Price of goods and services purchases by households for consumptions purposes, usually CPIs are calculated as a weighted average of the price change percentage for a selected basket of goods and services.

3. Producer Price Index: PPI
Is and Index/ measure for changes in the Price of factors of Productions purchases by firms for production purposes, including Cost of Labor, Machinery and equipment usually PPIs are calculated as a weighted average of the price change percentage for a selected basket of factors of production

3-Inflation Types and Causes
– Demand- Pull Inflation –Prices Increase from Excess of demand relative to amount of supply (Goods and services).
– The theory assumes that prices for goods and services are responsive to supply and demand forces, and will moves upward under the pressure of a high level of aggregate demand.

– Main causes of Demand-Pull Inflation:
1. Consumption – Increase in consumption and investment means an increase in AD. Shifting the AD curve to the Right , Due to changes in :
a. Level of Income & Wealth
b. Consumer Tastes, Preferences and Likeliness for the product
c. Future expectations for Income, Price/Availability of certain products
d. Population
e. Price of Related Goods Substitute
f. Price of Related Goods Complement

2. Government Spending – Increases Aggregate Demand (AD). Shifting the AD curve to the Right
3. Depreciation of the exchange rate – Increases price of imports and reduced price of exports, Therefore, less imports will be bought, and exports grow, leading to increased AD. Shifting the AD curve to the Right

Cost-Push Inflation – Prices Increase from Cost-push inflation when firms respond to rising costs by increasing prices in order to protect their profit margins. Could occur because of:

1. Increased cost of raw materials – This increased cost can be passed onto the customer through higher prices. Shifting the AS curve to the Right

2. Increased labour costs – Wage increases, possibly due to low unemployment. Less skilled workers, so pay increases. Fall in exchange rate – Increased price of imports means business may charge higher prices. Shifting the AS curve to the Right

4 – Relationship between Inflation and Unemploymnet Phillips curve

– The Phillips curve was developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. His Theory Claims that with economic growth comes inflation, which should lead to more jobs and less unemployment.

– The concept behind the Phillips curve states the change in unemployment within an economy has a predictable effect on price inflation. Increasing inflation decreases unemployment, and vice versa.

– In Other Words , the more Inflation rate in an Economy, the less Unemploymnet rate it will face. Simply because the assumption is with Higher Prices , Business Tends to make more profit and business is expanding which in turn opens the door for hiring more people and creating jobs and therefore Reducing Unemploymnet.

5- Business Cyle and AD-SRAS-LRAS Model
Business Cycle:
The Economy Keeps on Changing in Size and Direction , the Up and Down movement change in the State of any Economy during different periods of Time is what we call ,The Business Cycle.
The are four Stages are
• Expansion : Hight Level of Real GDP and Output , accompanied with High Prices and Low Unemploymnet
• Peak: The Highest level in an Expansion Phase , where Real GDP is at maximum , Inflations is increasing rapidly and Unemploymnet is very low
• Contraction : Lower Level of Real GDP and Out put , Decrease in Inflation and Rise in Unemployment
• Trough : Lowest Point in Consortium . Negative Inflation and very High Unemployment rates, where Real GDP is far below its Potential

ANALYSIS OF JAPAN’S INFLATION AND UNEMPLOYMENT RATE (1970-2018)
Inflation is defined as a sustained increase in the price level or fall in the value of money. It’s an imbalance between the supply of money and gross domestic product.
Unemployment refers to a situation in which the workers who are willing to willing to work and capable of working are not getting enough job opportunities.
Professor Philips showed using data that illustrated a short run trade off between inflation and unemployment. Philips curve is having a negative slope. Falling unemployment will cause inflation to rise as more people get jobs, they will be demanding more products as a result of which aggregate demand which rise which will create inflationary conditions.
So, we can conclude rate of unemployment is high, the rate of increase in money wage rates is low.
This happens because workers are reluctant to offer their services at less than prevailing rates when the demand of labor is low and unemployment is high so that wage rate falls very slowly and vice versa.

Here the curve is concave in shape and downward sloping. It shows that at A the inflation rate is 2% and unemployment rate is 6% but at point B inflation rate is 5% showed that unemployment rate is 3%.
A and B shows two different situations. So, the graph shows a curve which is denoted as Philips curve.

INFLATION AND UNEMPLOYMENT RATE OF JAPAN (1970-2018), presented in the following graphs:

EVALUATION OF THE GRAPH-
• The above graph shows that from 1970-80 there was a negative correlation between Japan’s inflation and unemployment rate.
• From 1980-90, it again shows that inflation rate increased unemployment rate increases. But in the middle of the year inflation rate decreased significantly, unemployment increased in the middle but the Japanese economy during the decade to control the situation.
• From 1990-2000, the economy showed a reverse trend where the inflation rate was decreasing but employment rate was increasing.in 1995, the inflation rate became negative which changed the Japan’s economic overview.
• From 2000-10, the inflation initially rose nearly 2007-08 negative but then again decreased, on the other hand unemployment decreased initially but then rose.
• From 2010-18, the inflation rate rose and the unemployment rate decreased, which showed inverse relationship between inflation rate and unemployment rate.

APPLICATION OF THEORY CURVE INTO THE LINE GRAPH-
• In the 1970s, inflation rate spiked up in the economy which resulted into lower employment rate. This means the outcome line graph satisfies the Philips curve condition as it is showing inverse relationship.
• In the 1980s, in this decade inflation rate started decreasing which created more unemployment in the country, which showed opposite relationship between inflation and unemployment rate. This also fits in the theory of Philips curve.
• In 1990s, in this decade Japanese economy suffered with great recession, that deflation was triggered by collapse in land and stock prices. That time many Japanese firms became insolvent that time inflation rate decreased even became negative in 1995 increased rate of worklessness which shows an inversely proportional relationship. This decade is not satisfying Philips curve.
• 2000 onwards, the conditions improved inflation rate increased slowly but from negative it became positive on the other hand unemployment increased, which supports the Philips curve condition.
CONCLUSION-
Japan’s economy also shows the inverse relationship between inflation rate and unemployment. The presented graph takes shape takes shape of a downward sloping curve which satisfies theory of Philips curve.

China
Now that we have analyzed how the notion of the Phillips curve relates to Japan, we can examine the same structure in China. Firstly, it is important to understand that the Phillips curve is a model which we use to analyze the interactions between macroeconomic factors. While this model does tend to be a general heuristic and an overall accurate predictor of the relation between inflation and unemployment, it is still not perfect and does not fully consider all aspects of the situation. Below is a time-series graph which demonstrates the relevant macroeconomic factors which we will analyze:
Graph 1. Unemployment Rate and Inflation Rate in China (1991-2018)

Graph 1. The values of the inflation rate and unemployment rate in China from the years 1991-2018. Data from the World Bank.
Another important factor to take into consideration with the Phillips curve model is that it only applies in the short-run. However, as we can see from the graph, the relationship between inflation and unemployment is not very obvious. Statistical analysis has shown that the direct relationship in the long-run indicates that increasing inflation by 1% leads to a 0.74% decrease in unemployment (Li & Liu, 2012). And, in the short-run, the statistics show that there is no significant relationship between inflation and unemployment, hence, it is possible for there to be both high economic growth and high unemployment; this violates the notion of Okun’s law which says that each incremental percentage decrease in employment corresponds with a 2% decrease in economic growth, and, correspondingly, Tobin’s effect does not hold either (Li & Lu, 2012). As we can see from graph 1, China’s unemployment has a long-term trend that is relatively stable and low; it fluctuates from between 3% to around 4.5%, which is close to the natural rate of unemployment in an economy. Nevertheless, the model of the Phillips curve does not really seem to demonstrate much significance, nor does the long-term relationship appear to be significant. If we look more closely at the unemployment rate in China we will see the following:
Graph 2. Unemployment Rate in China (1997-2018)

Graph 2. A time-series chart demonstrating the values of the percentage unemployment rate in China from 1991-2018. Data from the World Bank.
From Graph 2, we can see that the long-term trend of the unemployment rate has been one of growth. The unemployment rate has increased by around 2% from 1997, and it has since maintained a relatively stable level of around 4.5%. This does appear to be inconsistent with the Phillips curve model as there are no corresponding fluctuations in the unemployment rate following changes in the inflation rate. We can see this if we look directly at the inflation rate in China.
Graph 3. Inflation Rate in China (1997-2018)

Graph 3. A graph of the values of inflation in China from 1997-2018. Data from the World Bank.
This graph shows us how there have been plenty of short-term acute shocks to the inflation rate in China. However, the inflation rate itself does not have any concrete trend. The level of inflation in China does not appear to be stable and this leads to the insight that there may not be a good indicator of the unemployment rate itself in China. We can see that there is no concrete trend in inflation and that there is no strong relationship to the unemployment rate. To better grasp the whole picture, we shall examine the GPD per capita in China.
Graph 3. GDP Per Capita in China (1997-2018)

Graph 4. The change in GDP growth in China from 1997-2018. Data from the World Bank.
From this data we can see the relationship of inflation to GDP in China, and that the inflation rate does correlate strongly with the GDP growth in China. Furthermore, graph 4. also indicates how unemployment corresponds with changes in the GDP. While the unemployment rate has been relatively stable, we can see that the small fluctuations in the GDP correspond with the same fluctuations in the unemployment rate.
Discussion
So, what we have seen is that both inflation and unemployment are corresponding as expected with the changes in GDP, however, inflation itself does not demonstrate the expected relationship that we would have anticipated from the Phillips model. There are a few reasons why this may be the case. The first reason is that the collected data are not representative of the actual market conditions in China (Fei & Qianyi, 2013). This may be due to the fact that the data on unemployment is only related to the urban levels of unemployment, and that the inflation rate was measured through the CPI (Fei & Qianyi, 2013). This leads to confounding results as the urban levels of unemployment are not necessarily indicative of total unemployment in China, and the CPI may not properly measure the absolute level of inflation in China. Furthermore, the market structure in China is not entirely a free market, hence, the Phillips model may be inaccurate in its assumptions (Fei & Qianyi, 2013). This is due to the fact that there are fewer interactions between employees and employers which regulate the equilibrium on the labor market. Finally, the rapid growth in China may result in an economy that is not entirely representative of what the Phillips curve would expect. Overall, the data on unemployment and inflation are not accurate, and certain free-market assumptions of the Phillips curve are not met in China which is why we do not see what we would expect regarding China’s unemployment and inflation rate.

REFERENCES
Kitov, Ivan. “Inflation And Unemployment In Japan: From 1980 To 2050”. Researchgate, 2010, https://www.researchgate.net/publication/46462779_Inflation_and_unemployment_in_Japan_from_1980_to_2050/citation/download.
Li, Changshuai, and Zi-juan Liu. “Study On The Relationship Among Chinese Unemployment Rate, Economic Growth And Inflation.” Researchgate, 2012, https://www.researchgate.net/publication/279646841_Study_on_the_relationship_among_Chinese_unemployment_rate_economic_growth_and_inflation.
Mukher, Subho. “Inflation And Unemployment: Philips Curve And Rational Expectations Theory.” Economics Discussion, http://www.economicsdiscussion.net/inflation/inflation-and-unemployment-philips-curve-and-rational-expectations-theory/10625.
Fei, Q., & Qianyi, W. (2013). The Research On Inflation Rate And Unemployment Rate In China. Faculty of Economics & AdministrationUniversity of Malaya. Retrieved from https://worldconferences.net/proceedings/icssr2013/toc/063%20-%20QIN%20FEI%20%20-%20The%20research%20on%20inflation%20rate%20and%20unemployment%20rate%20in%20China.pdf

Li, C., & Liu, Z. “Study On The Relationship Among Chinese Unemployment Rate, Economic Growth And Inflation.” University Of Shanghai For Science And Technology, 2012. Retrieved from https://www.researchgate.net/publication/279646841_Study_on_the_relationship_among_Chinese_unemployment_rate_economic_growth_and_inflation.

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