Impact of inflation on Unemployment in Sri Lanka: Perspective of Phillips Curve


Aruppillai Thayaparan

Senior Lecturer, Vavuniya Campus, Vavuniya, Sri Lanka, aruppillaithayaparan@yahoo.com

Muhandiram Mudiyanselage Namal Muhandiram

Undergraduate Student, Vavuniya Campus, Vavuniya, Sri Lanka


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DOI: http://dx.doi.org/10.31014/aior.1992.01.02.20


Abstract

The aim of this study is to identify the impact of inflation on unemployment in Sri Lanka over the period 1990 - 2016 through the perspective of Phillips curve. For this purpose, the annual time series data for the above period were collected from central bank report in 2016. To achieve the objective, the inflation rate which represents by wage price index was considered as the dependent variable, and the unemployment rate was used as independent variable in the study. The collected data were analyzed using simple linear regression model and reciprocal model which represents the Phillips curve. Results of the coefficient of correlation in linear regression model suggest that inflation and unemployment have 87.5% of negative correlations among them while the model reveals that rate of inflation has a negative impact on unemployment in the country. Results of reciprocal model confirmed the concept of Phillips curve, and it has found that even if the unemployment rate increases indefinitely, the percentage decrease in wage price index floor will not be more than 12.23 percent per year and the results are statistically significant at 1% level. Also, the above model proves that Sri Lanka has attained a 20.8% of the natural growth rate of unemployment which is higher than under linear model while adjusted R2 is 0.93 in reciprocal model shows that compared to the linear model, the reciprocal model is the best-fitted one to measure the strength of the above two variables. Findings of the study may help the policymakers in formulating the policies to minimize the harmful consequences of inflation and level of unemployment in Sri Lanka.


Introduction

At present modern central banking practices mainly focusing on maintaining the economic and price stability is one of the main objectives of Central Bank of Sri Lanka. In this background, unemployment and inflation are the main macroeconomic concepts which are influencing the all economic aspects of a country. Inflation means that a continued increase in the general price level in an economy and nowadays it is measured by using price indices such as gross domestic product deflator, producer price index, consumer price index and wage price index. In case of Sri Lanka, wage price index and Colombo consumer price index are widely using in the calculation of inflation. Inflation, as measured by the consumer price index, reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. It is an indicator to measure the changes in the general level of consumer prices and used as one of the key indicators of inflation. Similarly, the wage price index is a price index which measures changes over time in wages and salaries for employee jobs, unaffected by changes in the quality or quantity of work performed. Changes in wages and salaries resulting from changes in the composition of the labor market are excluded from the wage price index movements. In 2017, the inflation rate for Sri Lanka was 6 %. Though Sri Lanka inflation rate fluctuated substantially in recent years, it tended to decrease through 1998 - 2017 period ending at 6 % in 2017.


Unemployment refers to that, people who were not employed but willing to be employed and who were seeking a job. The unemployment rate decreased to 4.4 percent in 2016 from 4.7 percent recorded in 2015. During 2016, the total labour force has grown by 1.2 percent, while a decline of 5.4 percent was recorded in the unemployed population, reflecting an increase in employment opportunities in the economy during 2016 compared to 2015. In theoretical point of view, in short run, there is an inverse relationship exist between inflation and unemployment. An increase in inflation leads to decrease in unemployment, and a decrease in inflation leads to decrease in unemployment which represents the trade-off between the above variables explained by Phillips curve in the short run.


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