Support the macroeconomic forecast, using thereal and financial frameworks, that Ireland's unemployment rate willremain stubbornly high over the coming years, perhaps falling somewhat...

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Support the macroeconomic forecast, using thereal and financial frameworks, that Ireland's unemployment rate willremain stubbornly high over the coming years, perhaps falling somewhat onlythrough rising emigration.

Answered Same DayDec 31, 2021

Solution

David answered on Dec 31 2021
29 Votes
It has been well observed that the financial market conditions in EU as a whole have improved
over the past year, but this improvement has not paralleled to the real economy. Economic
activity is not very satisfactory. Particularly for Ireland the GDP growth has been highly
fluctuating and unstable, though, in recent past it has been positive and increasing slightly.
Another important indicator for economic development is unemployment levels. The changes in
unemployment levels can be explained in both real economic framework and financial economic
framework.
In the real economy, the factors that come into play are mainly output, employment, prices,
money growth etc. There are two theories that explain the varying levels of unemployment: the
Phillips Curve/Equation and the Okun’s Law. The Phillips Curve maps the relation between
inflation and unemployment, whereas the Okun’s Law explains the relation between
unemployment and output growth. These shall be discussed in detail further.
The Phillips Curve is derived from the aggregate supply relation
P=P
e
(1+µ)F(u,z)
Here prices are inversely related to unemployment, since in an aggregate supply relation as
prices increase, output and employment increases.
The earlier versions of Phillips Curve indicate that if policy makers could agree to a higher
inflation rate for the economy then they could maintain a lower unemployment rate. But then the
notion of natural rate of unemployment came in. It was argued that even with a really high level
of inflation rate it may not be possible to reduce unemployment rate further since there exists a
natural rate of unemployment, so the tradeoff between inflation rate and unemployment rate
would disappear. By definition the natural rate of unemployment (un) is the unemployment rate
at which the actual inflation rate equals the expected inflation rate. In other words it is the rate of
unemployment required to keep inflation rate constant, so it is also called NAIRU: non-
accelerating inflation rate of unemployment. Also it was assumed that expected rate of inflation
was well approximated by last year’s inflation rate. So, the equation finally became:
πt - πt-1= -α(ut-un)
so the Phillips curve becomes a relation between actual unemployment rate, natural rate of
unemployment and change in inflation rate. Hence, the change in the inflation rate is related
inversely to the difference between actual and the natural rates of unemployment. The higher the
actual rate of unemployment above the natural rate, the lower is the inflation rate. There is
another intuition to this derivation, that it may be possible that unemployment rate has increased
and inflation rate has also increased, this may be due to the fluctuations in natural rate of
unemployment, here it may be the case that natural rate has increased more than the actual rate of
unemployment.
Also it must be noted that during deflation this relation may
eak or become weaker because
workers are generally reluctant to accept lower nominal wages even when the cut in wages is less
than the price level change.
Since it is inherent in our understanding that as output increases, employment rise and
unemployment should fall.
ut - ut-1= - gyt
where gyt is the growth rate of output from year t-1 to t.
But the relation may not be direct like this, i.e. the change may not be one to one. A change in
output growth does not fully translate to a change in unemployment levels. Firms adjust
employment less than...
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