Links Between Macroeconomic Problems And Their Interrelatedness (Copy)

10.2 Links Between Macroeconomic Problems and Their Interrelatedness

10.2.1 Relationship Between the Internal Value of Money and the External Value of Money

• Internal value: Purchasing power within the domestic economy (inverse of price level).
• External value: Exchange rate – value of domestic currency in terms of foreign currencies.
• Link: High domestic inflation → internal value falls → exports less competitive → currency depreciates (external value falls).

10.2.2 Relationship Between the Balance of Payments (BOP) and Inflation

• Current account deficit may worsen if inflation rises:
  • Higher domestic prices → exports less competitive → exports fall.
  • Imports become relatively cheaper → imports rise.
• Persistent deficits can weaken currency, potentially causing imported inflation.

10.2.3 Relationship Between Growth and Inflation

• High growth can create demand-pull inflation if AD rises faster than AS.
• Growth from productivity gains can reduce inflationary pressure.
• Overheating economy → rising wages, costs, and prices.

10.2.4 Relationship Between Growth and the Balance of Payments

• Growth increases incomes → higher demand for imports → potential current account deficit.
• If growth comes from export industries → may improve BOP.
• Export-led growth can strengthen currency; domestic-demand-led growth may worsen BOP.

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10.2.5 Relationship Between Inflation and Unemployment

Traditional Phillips Curve:

• Inverse short-run relationship between inflation and unemployment:
  • Low unemployment → upward pressure on wages → higher inflation.
  • High unemployment → lower wage pressure → lower inflation.

Expectations-Augmented Phillips Curve:

• Short run: Negative relationship exists.
• Long run: Phillips curve is vertical at the natural rate of unemployment (NRU).
• Adaptive expectations: Workers adjust expectations of inflation over time → no long-run trade-off.

Table – Short Run vs Long Run Phillips Curve: