INFLATION, RECESSION, AND UNEMPLOYMENT: THE INTERRELATIONSHIPS
I. ANALYSIS OF THE INTERRELATIONSHIPS In 1958, Professor A. W. H. Phillips set out empirical evidence to support the proposition that a significant relationship existed between the change in money wages and the level of unemployment.1 This proposition held that higher wages would be accompanied by lower unemployment. This relationship became known as the Phillips Curve, and it implied that a low rate of price inflation and a low rate of unemployment were inconsistent. This implication of the Phillips Curve led to the axiom that a tradeoff existed between inflation and unemployment. Thus, if the government acted to control inflation higher unemployment could be expected, and, conversely, if the government acted to boost employment, higher inflation could be expected. Employment and unemployment were associated with the level of economic activity. Thus, high levels of employment were associated with economic growth, while high levels of unemployment were associated with economic recession. Thus, a tradeoff relationship was also postulated between inflation and the level of economic activity. If the government acted to control inflation, a drop in the level of economic activity a recession could be expected. On the other hand, if the government acted to boost the level of economic activity, a higher rate of inflation could be expected.
1R. Rees, Economic Theory, 5th ed. (Harmondsworth, England: Penguin Books, Ltd., 1989), 345. Phillips' data were first used to support the theory in relation to the economy of the United Kingdom, and later, to support the theory in relation to the economy of the United States. For a little more than a decade, the theory appeared to hold. In the 1970s, however, the theory began to fail in predictions related to the economy of the United States. This failure has been variously attributed to massive war (Viet Nam) expendit...