Link between unemployment and inflation?

New research from the IMF suggests that the negative correlation (inverse relationship) between unemployment and inflation no longer exists (since 1995). The main reason is that central banks seem to have become more skilled at targeting inflation and managing inflationary expectations.

If this is the case, then maybe the long-run Phillips curve is horizontal (not vertical!) at the targeted rate of inflation. It would also imply that governments could increase aggregate demand and reduce unempolyment with no increase in the price level. However, the issue is whether the unemployment is cyclical or “voluntary “(mainly structural where there is a skills mismatch between the unemployed and the job vacancies on offer). If the unemployment is cyclical (there is spare capacity) then the AS curve could be effectively horizontal and an expansionary fiscal  or monetary policy would not raise prices. But if the unemployment is mainly structural (or seasonal/frictional/residual) then higher AD would be inflationary.


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