CHAPTER I
INTRODUCTION
1.1 BACKGROUND OF THE STUDY:
Undoubtedly, parts of the macroeconomic goals which the government strives to achieve are the maintenance of stable domestic price level and full-employment. Macroeconomic performance is judged by three broad measures- unemployment rate, inflation rate, and the growth rate of output (Ugwuanyi, 2004).
Unemployment has been categorized as one of the serious impediments to social progress. Apart from representing an enormous waste of a country‟s manpower resources, it generates welfare loss in terms of lower output thereby leading to lower income and well-being (Raheem, 1993).
Inflation on the other hand, has been a major problem in the country over the years. Inflation is a household word in many market oriented economies. Although several people, producers, consumers, professionals, non-professionals, trade unionists, workers and the likes, talk frequently about inflation particularly if the situation has assumed a chronic character, yet only selected few know or even bother to know about the mechanics and consequences of inflation.
Prior to the emergence of what became to be known as the unemployment and inflation trade-off or Phillips curve in 1958, unemployment and inflation were considered and treated in economics as distinct subjects. Keynes for instance described inflation as the excess of expenditure over income at full-employment level. He contended that the greater the aggregate expenditure, the larger the inflationary gap and the more rapid the inflation. As for unemployment, the Keynesian economists hold that an increase in unemployment reduces income, which reduces consumption, and reduces aggregate output. As a result, employment can be increased by increasing consumption or investment.
The monetarist on the other hand, explained inflation in terms of excessive growth of the money supply relative to real output. Their view on unemployment, however, is framed within the context of Milton Friedman‟s permanent income hypothesis. Based on the Permanent Income Hypothesis (PIH), a reduction in employment and current receipts only affects output to the extent that the anticipated income declines.
Each school of thought offered its own policy solutions. There were however, no major attempts made to examine inflation and unemployment simultaneously.
It was not until 1958, following the introduction of Phillip‟s curve by A.W. Phillips, that traditional economics began to examine unemployment and inflation simultaneously, thereby postulating a trade-off between inflation and unemployment- a lower inflation rate must be willing to put-up with a higher level of unemployment, and vice-versa. However, economists such as Milton Friedman and Edmund Phelps disapproved Phillips‟ curve thesis, stating that the trade-off between unemployment and inflation only existed in the short-run and that in the long-run, the Phillips curve is vertical. This led to the introduction of the Natural Rate Hypothesis.