Unemployment and Inflation: An Assessment of Canadian Macroeconomic Policy

Abstract

During the decade of the 1970s the Canadian economy was characterized by substantially higher rates of both inflation and unemployment than during the 1960s. This paper reviews some important research in recent years in an attempt to explain this occurrence and draws implications for policy formulation in the 1980s. The predominant view during the 1960s was that an inverse relationship exists between inflation and unemployment, i.e. periods of high inflation tend to be associated with periods of low unemployment and vice versa. The explanation for such an inverse relation between inflation and unemployment is based on three underlying relationships: the rate of price change is directly related to the rate of wage change and other factors; the rate of wage change is directly related to conditions in the labour market and (actual or expected) inflation; and conditions in the labour market are inversely related to the unemployment rate. This inverse relationship between the rate of price (or wage) change and the unemployment rate is called the Phillips curve after A.W. Phillips (1958) who presented striking empirical evidence that such an inverse relationship had existed in the United Kingdom for almost a century. The Phillips curve reflects something that is obvious to those involved in collective bargaining in Canada, i.e that, other things equal, a union can generally achieve a higher wage settlement when the economy is booming than when it is in a recession. The statistical verification of this relationship has proved to be a difficult task, however, and has been the subject of a highly technical statistical debate among researchers.' The conclusion which has emerged