<p>What you refer to is known as a Phillips curve and it does not hold generally but <strong>only</strong> in short-run (see Romer 2012 Advanced Macroeconomics Ch 7 5th ed).</p>
<p>You got the mechanism wrong in your question. You claim;</p>
<blockquote>
<p>When more people are working, they have the power to spend, which leads to an increase in demand. And prices (inflation) soon follow. The opposite is true when unemployment rises.</p>
</blockquote>
<p>But it is actually the other way around. It is the higher prices that leads to lower unemployment, not lower unemployment that leads to higher prices.</p>
<p>When prices <em>unexpectedly</em> increase, firms experience extraordinary high profits (relative to the natural state) and respond by hiring more workers. However, in long-run higher pressure on labor market raises wages, which then in turn lowers the profits and firm's demand for labor.</p>
<p>Next when there is unexpected drop in prices firms experience extraordinarily (relative to the natural state) low profits and respond by scaling down production, but in long-run wages again adjust to this lower price level.</p>
<blockquote>
<p>Why does when higher unemployment equates to lower inflation? I mean more people can be unemployed, but the Fed can still raise interest rate to drive inflation down. How do these two related?</p>
</blockquote>
<p>As explained above the causality is from prices to unemployment. Yes Fed can through interest rate, or other monetary policies, affect the rate of inflation. This in turn then leads to higher or lower unemployment <strong>in short-run</strong>.</p>

CC BY-SA 4.0
2024-07-21T00:36:48.860Z
Then what generally holds in the long run between inflation rate and unemployment?
HelloDarkWorld
CC BY-SA 4.0
2024-07-21T09:01:36.913Z
@HelloDarkWorld in long run they are generally orthogonal on each other
1muflon1
CC BY-SA 4.0
2024-07-21T18:50:56.730Z
What do you mean by "orthogonal"?
HelloDarkWorld
CC BY-SA 4.0
2024-07-21T20:01:50.227Z
@HelloDarkWorld if you would plot the unemployment on x axis and inflation on y axis they  would both be at right angle to each other. That means there is no meaningful economic relationship.
1muflon1
CC BY-SA 4.0
2024-07-20T21:51:13.060Z
2024-07-20T21:51:13.060Z
1muflon1
<p>I've read that inflation has historically had an inverse relationship with unemployment. This means that when inflation rises, unemployment drops. Higher unemployment, on the other hand, equates to lower inflation. When more people are working, they have the power to spend, which leads to an increase in demand. And prices (inflation) soon follow. The opposite is true when unemployment rises.</p>
<p>Why does when higher unemployment equates to lower inflation? I mean more people can be unemployed, but the Fed can still raise interest rate to drive inflation down. How do these two related? (Also, does higher unemployment causes lower inflation, or vice versa?)</p>
<p>Also, why does higher inflation lead to lower unemployment? In this case, the Fed can raise interest rates to combat inflation, but how does that relate to lower unemployment? (Also, does lower unemployment causes higher inflation, or vice versa?)</p>
<p>Thanks.</p>

<inflation><unemployment><united-states>
Relationship between drop in inflation rate vs. increase in unemployment rate (and vice versa)
HelloDarkWorld
# Relationship between drop in inflation rate vs. increase in unemployment rate (and vice versa)

(Asked by: username_0 on 2024-07-20)

I've read that inflation has historically had an inverse relationship with unemployment. This means that when inflation rises, unemployment drops. Higher unemployment, on the other hand, equates to lower inflation. When more people are working, they have the power to spend, which leads to an increase in demand. And prices (inflation) soon follow. The opposite is true when unemployment rises.

Why does when higher unemployment equates to lower inflation? I mean more people can be unemployed, but the Fed can still raise interest rate to drive inflation down. How do these two related? (Also, does higher unemployment causes lower inflation, or vice versa?)

Also, why does higher inflation lead to lower unemployment? In this case, the Fed can raise interest rates to combat inflation, but how does that relate to lower unemployment? (Also, does lower unemployment causes higher inflation, or vice versa?)

Thanks.

**Tags:** inflation, unemployment, united-states

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## 1 answers

### Answer by username_1 on 2024-07-20. Score: 1 | Accepted answer

What you refer to is known as a Phillips curve and it does not hold generally but **only** in short-run (see Romer 2012 Advanced Macroeconomics Ch 7 5th ed).

You got the mechanism wrong in your question. You claim;

> When more people are working, they have the power to spend, which leads to an increase in demand. And prices (inflation) soon follow. The opposite is true when unemployment rises.

But it is actually the other way around. It is the higher prices that leads to lower unemployment, not lower unemployment that leads to higher prices.

When prices *unexpectedly* increase, firms experience extraordinary high profits (relative to the natural state) and respond by hiring more workers. However, in long-run higher pressure on labor market raises wages, which then in turn lowers the profits and firm's demand for labor.

Next when there is unexpected drop in prices firms experience extraordinarily (relative to the natural state) low profits and respond by scaling down production, but in long-run wages again adjust to this lower price level.

> Why does when higher unemployment equates to lower inflation? I mean more people can be unemployed, but the Fed can still raise interest rate to drive inflation down. How do these two related?

As explained above the causality is from prices to unemployment. Yes Fed can through interest rate, or other monetary policies, affect the rate of inflation. This in turn then leads to higher or lower unemployment **in short-run**.

> **Comments:**
> **username_0**: Then what generally holds in the long run between inflation rate and unemployment?  
> **username_1**: @HelloDarkWorld in long run they are generally orthogonal on each other  
> **username_0**: What do you mean by "orthogonal"?  
> **username_1**: @HelloDarkWorld if you would plot the unemployment on x axis and inflation on y axis they  would both be at right angle to each other. That means there is no meaningful economic relationship.  

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