Inflation and unemployment trade-off: Threshold level of inflation to support employment schemes

Abstract

Inflation and unemployment are the two of the most important macroeconomic variables that play a vital role in the development of any economy. Many countries now have started implementing Inflation Targeting (IT) which sets explicit target for inflation to keep it at reasonably low levels, India is one of the recent country to adopt IT as per the announcement made by RBI in 2015. Ideally any country would simultaneously like to keep both the inflation and unemployment at low levels. Phillips curve which tries to explain the relationship between inflation and unemployment shows the existence of a historical inverse relationship between the two. This when looked at from a policy standpoint essentially means that measures taken to control inflation would impact the unemployment rate negatively. In developing countries like India, prior research done suggests that inflation and unemployment follow the Phillips curve. Hence, the purpose of this project is to study the existence of Phillips curve in the context of India. The project also aims at finding the tolerable inflation rate that the people are willing to bare, to allow the government to undertake measures to improve the employment level in the country. The tolerable inflation rate that is to be determined in this project would be recommended to the Reserve Bank of India as an assistance to the RBI and the Government in policy matters to improve the effectiveness of IT regime.