Economic growth, inflation, and unemployment in Australia and the United States

Inflation Economic Growth and Unemployment in Australia and the United States

Comparison And Contrast

The objective of this work is to compare and contrast the economic growth, unemployment and/or inflation of two or more countries to each other or to the United States. For this purpose this work has chosen to compare and contrast Australia and the United States and in terms of all these factors as mentioned above.

II. OVERVIEW of U.S. ECONOMY

The economy of the United States has a GDP that was more than $13 trillion and "...constitutes 22% of the gross world product." (2008) Additionally, the U.S. ranks as the third or eighth highest GDP per capita..." (Trading Economics, 2008) Trading Economics (2008) relates that U.S. workers tend to "work considerably more hours annually, take less vacation, and produce more than an hour than workers in other developed nations." It is reported that 155 million individuals were employed in 2005 with 80% being full time workers and more than 79% of workers being employed in the service sector." (Trading Economics, 2008) the U.S. dollar is stated to be a "weighted geometric mean of the dollar's value compared to the Euro (EUR), Japanese yen (JPY), Pound sterling (GBP), Canadian dollar (CAD), Swedish krona (SEK) and Swiss franc (CHF). The dollar has been surpassed by the euro since December 2006 "in terms of combined value of cash in circulation." (Trading Economics, 2008)the following figure illustrates the history of the U.S. dollar index for the period January 2005 through April 2008.

U.S. Dollar Index (January 2005 - April 2008)

Source: Trading Economics (2008)

III. UNEMPLOYMENT RATES & INFLATION RATES COMPARED and CONTRASTED

The "Debate on Alternatives for Monetary Policy in Australia" state that in the case of a "unique natural rate of unemployment...then following an inflation target will automatically cause monetary policy to expand when the rate of unemployment is high. This automatic expansion may be slow in coming and follow a significant period of time during which the rate of unemployment is high but eventually this automatic response would occur. This is because an unemployment rate in excess of the natural rate will create downward pressure on the rate of inflation. This downward pressure will cause the rate of inflation to fall. Eventually the rate of inflation and the forecast of future inflation under unchanged monetary policy will fall below the target range and this will require the Reserve Bank of Australia to expand monetary policy in order to meet the inflation target" (McDonald, nd) This work relates however, that it may very well be that this is not such a unique occurrence after all as it was found by Staiger, Stock and Watson (1997) that estimates (of the natural rate of unemployment) are imprecise in that "forecasts of inflation are similar whether the natural rate of unemployment is assumed to be 4.5, 5.5, or 6.5%." (McDonald, nd) the Phillips loops, "first documented by Phillips (1958) demonstrates that "changes in the rates of unemployment do appear to cause changes in the rate of inflation." (McDonald, nd) the unemployment rate in Australia beginning January 2006 through March 2008 is shown in the following chart labeled Figure 3.

Unemployment Rate in Australia (January 2006 - March 2008)

Source: Trading Economics (2008)

The inflation rate in the country of Australia for the period beginning March 2006 and ending March 2008 is shown in the following chart labeled Figure 4.

Australia Inflation Rate (March 2006 - March 2008)

Source: Trading Economics (2008)

One may observe from comparison of the unemployment rate and inflation rate during the specified period of time that as unemployment rates climb in Australia that inflation has climbed as well overall. The following figure labeled figure 5 shows the history of unemployment in the United States for the period beginning January 2006 and ending March 2008.

Unemployment Rate in the U.S. (January 2006 - March 2008)

Source: Trading Economics (2008)

The inflation rate in the United States for the period beginning March 2006 and ending March 2008 is shown in the following chart labeled Figure 6.

U.S. Inflation Rate (March 2006 - March 2008)

Source: Trading Economics (2008)

As one can easily see from the two figures above labeled Figure 5 and Figure 6 the inflation rate in the United States is higher overall in March 2008 than in the beginning of this period in February 2006 and unemployment rates having gone through many changes are furthermore higher at the end of this period than in the beginning of this period in February 2006. As the unemployment rates seesawed up and down in the United States the threat once having gained, momentum appears to have created a driver for rates of inflation that became sensitive to changes in the rates of unemployment historically.

Ian McDonald, in his discussion on "The Debate on Alternatives for Monetary Policy in Australia" goes on to relate additional information and states that the primary reason of the."..Australian estimates of the natural rate of unemployment is less precise than the United States estimates is probably related to the larger variation of the actual rate of unemployment in Australia." (McDonald, nd) This is based upon the "tendency of natural rate estimates to follow the actual rate of unemployment." (McDonald, nd) According to McDonald, Malcolm Edey supports the targeting of the inflation systems "over money-supply setting or exchange-rate setting systems" because this systems "encompass these other systems and therefore can outperform them." (McDonald, nd) it is acknowledged by Edey that this "final targeting systems can yield complex rules..." And in fact, it is the very "complexity of these rules which gives them the potential to outperform the simple rules of the other systems considered." (McDonald, nd) Gained within the use of these complex rules is the "...flexibility to adjust monetary policy in the light of economic developments." (McDonald, nd) the advantages are not so much monetary policy commitments but instead advantages of "transparency and credibility..." And of "fostering public understanding about the behavior of the economy and the operation of the policy framework." (McDonald, nd) Australia's advantage is stated to be an inflation target that emphasizes a "narrow range of two to three per cent..." And encouraging the public to have expectations of that rate. McDonald states that this of course, is "provided of course a track record of inflation in the two to three per cent range is established." (McDonald, nd) This is a simplistic inflation target, which enables the consensus of expectations related to changes in the rates of inflation. It is finally noted that "on the other hand, acts which lower prices at a given level of activity can be seen to have an 'employment benefit' in that they provoke an expansionary response." (McDonald, nd; 72) it is held by some participants in the debate as reported by Ian McDonald that the "...current specification of the inflation target in Australia was too vague..." (McDonald, nd; 73) the United States on the other hand, is focused much more closely on clearly targeting inflationary rates in forecasting which appears to cause less fluctuation in the rates of inflation when unemployment rates change and rise. Some participants in this debate believed that "forward-looking inflation-targeting framework will always pay attention to fluctuations in output and employment, as these fluctuations affect inflation. The clarification of the timeframe before the inflation will return to the level that has been targeted following the shock of employment rate shifts is "the horizon of the policy rule." (McDonald, nd; 73) Inflation rates grew for two years while interest rates were rising and yet unemployment was lowering during this time. In the United States, it can be noted as well that while unemployment rates grew inflation rates fell. Monetary policy and inflation targeting are similar in the United States and Australia.

SUMMARY

Because employment rates do impact inflationary rates during times of change and in times specifically when unemployment rates rise it is necessary specifically during these times to inform the public through clear policy and expectations as to what is expected thereby cushioning the shock of the impacts of unemployment on inflation rates. There has however, been research reviewed in this study that shows that use of an inflation target is most useful to understand when lower of prices can result in a benefit to levels of employment.