**2. Unemployment and inflation relationship: Phillips curve**

The relationships between macroeconomic variables in an economy and the reciprocal interactions of these variables are crucial to policy proposals. The intervention was deemed unnecessary because it was assumed that the economy would always reach the full employment balance thanks to its spontaneous, intrinsic mechanisms at the time of the classic-neoclassical paradigm. However, the Great Depression system in 1929 has shown that it is insufficient to solve many problems such as especially unemployment and furthermore problems become deeper than before. Keynes' masterpiece General Theory has been a turning point in terms of the government's intervention in the economy and the nature of this intervention [7].

It can be said that the Classic-Neoclassical paradigm is also in crisis with the publication of the General Theory which Keynes expressed his views about the crisis. Microeconomic analyses which examine the optimum distribution of resources in neoclassical theory were replaced by the analysis of macroeconomic variables such as employment, national product, total lack of demand in the post-Keynes period, and analysis of interactions between these variables. In this context, the study was published with the title "The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957" [8]. This study led to a long discussion of the relationship between inflation and unemployment and the effectiveness of its policies to be implemented. Reflecting the views of neoclassical Synthesis Keynesian economists, the original version of the Phillips Curve shows the relationship between the rate of increase of nominal wages in the UK between 1861 and 1957, i.e. wage inflation and the unemployment rate [9]. Phillips said the hypothesis that the change in monetary wage rates (the rate of change of money wage rates) is determined by the level of unemployment and the rate of change of unemployment can be generally accepted. These conclusions are of course tentative. There is need for much more detailed research into the relations between unemployment, wage rates, prices and productivity [8].

Paul Samuelson and Robert Solow examined the relationship between inflation and unemployment by substituting the Consumer Price Index in the United States instead of the wage rate, and thus developed a new interpretation in 1960. In this study, it was concluded that if unemployment was held at 5–6% (if unemployment were held at 5 to 6 percent) the price index could be stable, whereas if unemployment was held at 4%, there could be a 2% increase in inflation [10].

This interpretation, also called the Phillips Curve, which has been modified and improved has gained great importance in the literature and has become meaningful in terms of economic policy in this way. The Philips Curve shows the inverse relationship between the unemployment rate with the inflation rate, compatible with the Keynesian approach, high inflation rate, low unemployment rate and low inflation with high unemployment rate means that a choice can be made between combinations of. The governments which can be called' Mitte-Rechts 'prefer the first combination, while the governments that are' left-of-Centre '('Mitte-Links') have adopted the second policy proposal. The stagflation process, called the combination of rising inflation and unemployment, was seen after the 1970 oil crisis. This situation has led to questioning and discussion of the stable relationship between prices and unemployment [9].

The fact that the stagflation phenomenon that emerged in the late 1960s could not be explained by Phillips Curve Analysis intensified the debate on the Phillips curve durin this period. Under the fine-tuning policy, for example, if the government wants to reduce unemployment, it must increase total demand. However, it is necessary to endure some inflation increase with increasing total demand.

alignment or contradictions between the intended objectives and the instruments to be implemented should be taken into account when making policy proposals. In this study, the relations between growth, unemployment, inflation and current account are first discussed in theoretical terms and it is examined whether these theories are

*Linear and Non-Linear Financial Econometrics - Theory and Practice*

Accordingly, the Phillip curve analysis, which explains the nature of the relationship between unemployment and inflation, was analyzed in detail by comparing interpretations of different economic approaches. In the case of inflation, the demand-side policies will have an effect on these variables. In contrast, according to the Monetarist and New Classical approach, demand-side policies are ineffective and therefore unnecessary. In more accurate terms, the relationship between unemployment and inflation is temporary in the short-term because both variables may change in the same direction in the long term. After this topic was discussed in the first part of the study after then the case of Turkey was examined and discussed. Another theoretical approach that attempts to explain the relationship between macroeconomic variables analysis are known as Okun's law. The Okun's law suggests an inverse relationship between the growth rate and the unemployment rate. In the one study is determined by Okun with regression analysis between 1947 and 1960. This law that explained every %1 growth rate in the United States reduced the decreased the unemployment rate 0.5% points. However, the growth rate must exceed a certain level and average or trend growth rate in order to affect unemployment. Although the Okun's law is tested for different countries which are generally verified the nature of this relationship varies considerably from country to country. The Okun's law was explained in details in the second section and its validity was tested for Turkey in the last section with symmetric and asymmetric causality. The another important indicator of a country's economic performance in macroeconomics is the current account balance. There is a very close relationship between the current account deficit and the growth rate which has become an important prob-

In the many literature of econometric studies based on the relationships between economic growth, current account deficit, inflation and unemployment have also been conducted. In their study, [1] conducted the necessary econometric analyzes to determine the relationship between the variables using the monthly data 2007– 2014 economic growth, unemployment and inflation. In the study under discussion, there is a causality analysis between the current account deficit, inflation problem and growth [2]. The study [3] Brazil, Russia, India, using annual data for the period 1993–2011 belong to China and Turkey, the panel analyzed the causal relationship between the current account deficit and inflation method. The relations between Azerbaijan, Kazakhstan, Kyrgyzstan, Macedonia and Turkey for the period 1996– 2012 using data on inflation and unemployment with panel cointegration analyze and causality tests [4]. They are studied causality and vector error correction model between inflation, economic, growth and unemployment in North African Countries [5]. In the study the inflation and economic growth are taken for Nigeria with regression analysis. They studied the inflation, economic growth, unemployment relationship with Var analysis for Iraq. In this study, the relationship between the current account deficits, economic growth and the current account with certain

The last part of our chapter we determined the relationship between the current

When we look at these relations in terms of causality, it is stated that the direction of the relationship in question will yield different results when viewed as asymmetric and symmetrical and should be adapted accordingly to their economic policies.

account and the growth rate and they were explained with the national income

inequality and the nature of this relationship was discussed in Turkey.

valid or not in the case of Turkey.

lem especially for developing countries.

explanations are wanted to examined [6].

**286**

According to Friedman and Phelps, the economy does not stabilize after the inflation rate rises. Because if the adaptive expectations approach is valid, when inflation rises, inflation-related expectations also rise. In other words, the Phillips curve shifts to the right and unemployment returns to its natural rate again. In such a case, it is possible to reduce unemployment below its natural level with ever-increasing inflation. In this context, Friedman suggests that the stable relationship between unemployment and inflation is due to differing expected inflation and realized inflation rates. When the expected and current inflation rates are the same, there will be no change in real wages and hence the level of employment. Because in this case, the expected inflation rate will be reflected in long-term wage contracts [11]. To sum up, according to Friedman's analysis, the negative-sloping Phillips curve, that is, the existence of an inverse relationship between inflation and unemployment is temporary. Friedman specifically emphasizes here that the temporary trade off relationship is due to false expectations about inflation that lead to rising inflation. In the long term, as a result of the revision of inflation expectations, the exchange relationship disappears and the curve becomes perpendicular to the horizontal axis [12].

According to neoclassical synthesis Keynesian economists the Phillips curve is negatively sloped that means there is an exchange between unemployment and inflation whereas the Monetarist economists argue that is only true in the short term. In contrast, the new classical approach suggests that the Phillips Curve is a right perpendicular to the horizontal axis both in the short run and long run. According to the new classical analysis, according to rational expectations, unemployment always remains at the level of natural unemployment, except for unforeseen shocks and random errors under the assumption that there will be no systematic error in the forecast of inflation. In other words, there is no relationship between unemployment and inflation. This situation is explained by the Lucas 'surprise'supply function is determined,

$$\mathbf{Y} - \mathbf{Y}\_{\mathbf{n}} = \mathfrak{a} \ (\mathbf{P} - \mathbf{P}^{\mathfrak{e}}) \tag{1}$$

amount of unemployment to be endured. In contrast, the Monetarist and new classical economists, who represent the orthodox approach, suggest that these two variables are independent of each other and that demand-side policies will have no effect on them. In this approach, which argues that inflation is always a monetary phenomenon the public intervention in the economy with cyclical policies will have

*Relationship between unemployment rate and inflation rate (2004–2019). Source: Turkish World*

*Relationship between Economic Growth, Unemployment, Inflation and Current Account…*

ment rate and the inflation rate in Turkey. According to the chart, there is an inverse relationship between the unemployment rate and the inflation rate in general. In the period studied, the rate of increase in prices is low or vice versa during periods when unemployment rate is high in Turkey. In the post-2008 period when the global crisis occurred, unemployment decreased from 13 to 8% between 2009 and 2012, while the inflation rate remained unstable and rose from 6 to 9%. This can be seen as a result of expansionary monetary policies implemented in developed countries to counter the negative effects of the crisis on unemployment. As with other developing countries, capital inflows have accelerated with the increase in money supply in the global dimension. Intensive capital inflows can be said to have an effect that reduces unemployment by providing a high growth rate. The unemployment rate has started to rise after reaching its lowest level in 2012 and is nearing 14% in 2019. During this period, the inflation rate was bumpy but increased from 9 to 15%. This period occurs for the inflation and unemployment rising together and

The below mentioned **Figure 1** shows the relationship between the unemploy-

**Figure 1** shows that the rate of unemployment and inflation rose by 4 and 7 percentage points respectively in the period 2004–2019. Therefore, while it is possible to talk about the existence of a relationship between inflation and unemployment rate in the short term, it is observed that there is no exchange between the two variables in the long term. In other words, it is predictable that the expected impact of policies aimed at lowering the unemployment rate on inflation will be limited or short-term. Similarly, policies aimed at price stability should be expected to have a

**3. Relationship between growth rate and unemployment: Okun's law**

One of the highlights of the analysis on unemployment is the relationship between growth and unemployment. The main expectation of given the main

unnecessary and negative consequences.

*DOI: http://dx.doi.org/10.5772/intechopen.93833*

**Figure 1.**

**289**

*Bank – TCMB.*

points to stagflationist developments.

limited and short-term impact on unemployment.

According to the current price level equation if the deviation (PPe) between the (P) with the expected price level (Pe) be more greater the differences between the actual production (Y) and the natural balance in the level of output (Yn) will be more as (Y � Yn). Since inflation is the same as expected inflation in rational expectations approach, current income is always at the level of natural income and unemployment is also at the level of natural and natural unemployment. It is possible to deviate from the natural level of unemployment if the inflation estimate is incorrect. Such a situation can only be explained by a "surprise" development [13], meaning that the actual inflation rate deviates from the expected inflation rate. The fact that the economy is always in balance at the natural level of unemployment means at demand-side policies are unnecessary. According to The New Classical Macroeconomics theory, which has Monetarist views at the point of origin, the conjuncture policy is ineffective. With monetary policies, it is not possible to increase production and employment levels even in the short term.

The existence of a relationship between unemployment and inflation, that is, tradeoff between these two variables or not is important for policy proposals. The Keynesian economists argue that if there is an exchange between unemployment and inflation, it is possible to achieve the desired result with the demand-side policies to be implemented. In this context, expansionary monetary and fiscal policies will lead to demand expansion, resulting in unemployment reduction, while demand-biased inflation increases will occur. On the contrary if it is necessary to lower inflation, the shrinking policies that will be implemented require some

*Relationship between Economic Growth, Unemployment, Inflation and Current Account… DOI: http://dx.doi.org/10.5772/intechopen.93833*

**Figure 1.**

According to Friedman and Phelps, the economy does not stabilize after the inflation rate rises. Because if the adaptive expectations approach is valid, when inflation rises, inflation-related expectations also rise. In other words, the Phillips curve shifts to the right and unemployment returns to its natural rate again. In such a case, it is possible to reduce unemployment below its natural level with ever-increasing inflation. In this context, Friedman suggests that the stable relationship between unemployment and inflation is due to differing expected inflation and realized inflation rates. When the expected and current inflation rates are the same, there will be no change in real wages and hence the level of employment. Because in this case, the expected inflation rate will be reflected in long-term wage contracts [11]. To sum up, according to Friedman's analysis, the negative-sloping Phillips curve, that is, the existence of an inverse relationship between inflation and unemployment is temporary. Friedman specifically emphasizes here that the temporary trade off relationship is due to false expectations about inflation that lead to rising inflation. In the long term, as a result of the revision of inflation expectations, the exchange relationship disappears and the curve becomes perpendicular to the hor-

*Linear and Non-Linear Financial Econometrics - Theory and Practice*

According to neoclassical synthesis Keynesian economists the Phillips curve is negatively sloped that means there is an exchange between unemployment and inflation whereas the Monetarist economists argue that is only true in the short term. In contrast, the new classical approach suggests that the Phillips Curve is a right perpendicular to the horizontal axis both in the short run and long run. According to the new classical analysis, according to rational expectations, unemployment always remains at the level of natural unemployment, except for unforeseen shocks and random errors under the assumption that there will be no systematic error in the forecast of inflation. In other words, there is no relationship between unemployment and inflation. This situation is explained by the Lucas

According to the current price level equation if the deviation (PPe) between the (P) with the expected price level (Pe) be more greater the differences between the actual production (Y) and the natural balance in the level of output (Yn) will be more as (Y � Yn). Since inflation is the same as expected inflation in rational expectations approach, current income is always at the level of natural income and unemployment is also at the level of natural and natural unemployment. It is possible to deviate from the natural level of unemployment if the inflation estimate is incorrect. Such a situation can only be explained by a "surprise" development [13], meaning that the actual inflation rate deviates from the expected inflation rate. The fact that the economy is always in balance at the natural level of unemployment means at demand-side policies are unnecessary. According to The New Classical Macroeconomics theory, which has Monetarist views at the point of origin, the conjuncture policy is ineffective. With monetary policies, it is not possible to

increase production and employment levels even in the short term.

The existence of a relationship between unemployment and inflation, that is, tradeoff between these two variables or not is important for policy proposals. The Keynesian economists argue that if there is an exchange between unemployment and inflation, it is possible to achieve the desired result with the demand-side policies to be implemented. In this context, expansionary monetary and fiscal policies will lead to demand expansion, resulting in unemployment reduction, while demand-biased inflation increases will occur. On the contrary if it is necessary to lower inflation, the shrinking policies that will be implemented require some

<sup>Y</sup> � Yn <sup>¼</sup> <sup>α</sup> <sup>P</sup> � <sup>P</sup><sup>e</sup> ð Þ (1)

izontal axis [12].

**288**

'surprise'supply function is determined,

*Relationship between unemployment rate and inflation rate (2004–2019). Source: Turkish World Bank – TCMB.*

amount of unemployment to be endured. In contrast, the Monetarist and new classical economists, who represent the orthodox approach, suggest that these two variables are independent of each other and that demand-side policies will have no effect on them. In this approach, which argues that inflation is always a monetary phenomenon the public intervention in the economy with cyclical policies will have unnecessary and negative consequences.

The below mentioned **Figure 1** shows the relationship between the unemployment rate and the inflation rate in Turkey. According to the chart, there is an inverse relationship between the unemployment rate and the inflation rate in general. In the period studied, the rate of increase in prices is low or vice versa during periods when unemployment rate is high in Turkey. In the post-2008 period when the global crisis occurred, unemployment decreased from 13 to 8% between 2009 and 2012, while the inflation rate remained unstable and rose from 6 to 9%. This can be seen as a result of expansionary monetary policies implemented in developed countries to counter the negative effects of the crisis on unemployment. As with other developing countries, capital inflows have accelerated with the increase in money supply in the global dimension. Intensive capital inflows can be said to have an effect that reduces unemployment by providing a high growth rate. The unemployment rate has started to rise after reaching its lowest level in 2012 and is nearing 14% in 2019. During this period, the inflation rate was bumpy but increased from 9 to 15%. This period occurs for the inflation and unemployment rising together and points to stagflationist developments.

**Figure 1** shows that the rate of unemployment and inflation rose by 4 and 7 percentage points respectively in the period 2004–2019. Therefore, while it is possible to talk about the existence of a relationship between inflation and unemployment rate in the short term, it is observed that there is no exchange between the two variables in the long term. In other words, it is predictable that the expected impact of policies aimed at lowering the unemployment rate on inflation will be limited or short-term. Similarly, policies aimed at price stability should be expected to have a limited and short-term impact on unemployment.
