Inflation, Unemployment and Phillips Curve Dissertation

2.5. Limitations of the study

At the level of the limitations, these refer to the usage of secondary information, as opposed to the collection of primary data through the direct analysis of the Chinese market. This limitation is nevertheless addressed through the integration of multiple sources of valid and verifiable information, leading as such to the creation of solid, relevant and reliable findings.

The second limitation is one common to all research endeavors, namely the inability of the research project to answer all questions related to the topic under assessment. These topics could however constitute grounds for future research projects, supporting as such the academic development. These questions refer to the following:

1. What are the history, evolution and importance of inflation and unemployment?

2. What are the characteristics of the Phillips curve in other global regions, such as the United States or Japan?

3. The Phillips curve in China is scattered and inconsistent and this is attributed to the highly volatile inflation of the emergent economy. Is there a particular trend to explain the curve based on the level of economic development?

3. Inflation, unemployment and their definitions

This third chapter of the research process focuses on the introduction and presentation of the concepts of inflation and unemployment in a highly comprehensive manner. Emphasis is placed on the definition of the two concepts, their measures and the issues they raise.

3.1. The problem of inflation

3.1.1. The definition of inflation

Inflation is often a commonly used and heard term and it is generally described in terms of purchasing prices, consumer indexes or purchasing power. Inflation in essence refers to the increase in prices, in comparison to the real economic growth, and the resulting ability of the population to make purchases. High levels of inflation increase the prices and reduce purchasing power, whereas lower levels of inflation reduce prices and increase purchasing powers. The general political scope of nations is to decrease the inflation or maintain it at a low level. The specialized literature presents the reader with a wide array of definitions for inflation, such as those below:

"Inflation is a process of continually rising prices, or equivalently, of continually falling value of money."

This definition is blamed as lacking specifics, but is often accepted as it is relevant for most situations.

Investopedia defines inflation as "the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum."

Inflation represents a "sustained rise in the aggregate, or general, price level."

Joyce Hart then explains that in order for inflation to occur, prices have to increase considerably and over an extended period of time. And the prices of all necessary commodities have to suffer increases. The author of How inflation works notes: "Inflation is more than just an increase in the cost of goods and services. For economists to declare that a country's economy is indeed in a state of inflation, the cost of food, gasoline, and other important goods that people need have to not only rise significantly, but this rise also has to last over a relatively long period of time."

In order to best understand the mechanism of inflation, one should consider the following example: a bottle of wine now costs $20, and the annual inflation is of 3 per cent. By the end of the current year, the new price of the bottle of wine would be adjusted by inflation, namely it would increase. In a context in which:

Adjusted price = initial price + initial price x inflation rate,

the new price of the bottle of wine would be of $20.6, retrieved with the aid of the following equation:

New price = 20 + 20 x 0.03 = 20 + 0.06 = $20.6

If during the following year, the inflation rate increases to a 10 per cent rate for instance, the price of the bottle of wine would be even higher. The new price would be as such adjusted by the 10 per cent inflation rate and it would come to sum up a total of $22.66, price retrieved with the aid of the following equation:

New price = 20.6 + 20.6 x 0.1 = 20.6 x 1.1 = $22.66

3.1.2. Measures of inflation

3.1.2.1. How inflation is measured

Inflation is generically measured with the use of two specific models:

The GDP deflator

The Consumer Price Index

The deflator of the gross domestic product is understood as the weighted average price of all products and services delivered by a national economy. In other words, it represents the most comprehensive and clearest means of establishing and assessing national price levels.

The Consumer Price Index is the weighted average price of the products and services purchased within a traditional household. The GDP deflator is the most comprehensive and complex tool, but it is used less commonly than the CPI. This is explained by the fact that the GPD deflator also considers the products and services purchased by economic agents or by the government, whereas the CPI only selects the products and services bought by the households, being as such more relevant.

The annual inflation rate represents the percentage increase in the prices of goods and services registered in one year relative to the previous year. The annual inflation rate is computed with the aid of the price levels from the current and the previous years. The formula is revealed below:

In which:

IR is the inflation rate

PL (t) is the price level of the current year, and PL (t -- 1) is the price level from the previous year

In the United States, a third method is available for the measurement of the inflation rate, and this is represented by the Producer Price Indexes. This method implies the analysis of the various indexes created by domestic producers and revealing the changes in the retail prices of their products and/or services.

3.1.2.2. Global values of inflation

In terms of actual values of inflation, these differ across countries and are determined by state specific elements. Nevertheless, the editors at the Central Intelligence Agency have noted that the average inflation rate in developed countries is of 2.5 per cent whereas in emergent states, it has an average value of 5.6 per cent.

In a larger formulation, the inflation rates for developed countries traditionally fall between 0 and 4 per cent, whereas the values for emergent states fall between 5 and 10 per cent. At a general level, the trend in the inflation rates of the past several years has been that of decreasing inflation rates and this has been due to intensifying levels of competition in the international market, as well as the restricted demands as a result of the internationalized financial crisis.

Similar to its general economic state of an emergent country, China falls in the second category of inflation rate levels, with an annual inflation rate of 5 per cent. The value has nevertheless decreased and China in fact registers one of the lowest inflation rates on the globe. The Central Intelligence Agency has developed a top of 224 states and ranked them by inflation. China is to be found on the 141st position.

The leading five states with the lowest inflation rates are:

Seychelles with -2.20 per cent inflation rate

Ireland with -1.60 per cent inflation rate

Gabon with -1.30 per cent inflation rate

Latvia with -1.20 per cent inflation rate and Faroe Islands with -1.10 per cent inflation rate.

At the other pole, with the highest levels of inflation, sit:

Uzbekistan with 15.00 per cent inflation rate

Eritrea with 20.00 per cent inflation rate

Argentina with 22.00 per cent inflation rate

The Democratic Republic of Congo with 26.20 per cent inflation rate and Venezuela with 29.80 per cent inflation rate.

Other inflation rates worth mentioning include:

Japan with -0.70 per cent inflation rate

Germany with 1.10 per cent inflation rate

The United States of America with 1.40 per cent inflation rate

France with 1.50 per cent inflation rate and The United Kingdom with 3.30 per cent inflation rate.

More inflation rates by country are presented in Annex 1.

3.1.3. Types of inflation

Helmut Frisch identifies four elements by which inflation can be classified. These refer to the working of the market mechanism, the rate at which prices increase, the expectations of inflation and the causes of inflation. Based on the first criterion -- the working of the market mechanism, inflation can be either.....