Explain why a trade off occurs between unemployment and inflation.

Policies which seek to lower one usually raise the other. For example, a re-inflationary policy which aims to raise aggregate demand in order to reduce demand-deficit unemployment will usually raise inflation at the same time. For example, cutting interest rates will stimulate demand, so and so output and employment will rise, however, providing the economy is not on the horizontal part of the aggregate supply curve, inflation will rise.
Similarly, if the government aims to reduce inflation by increasing interest rates, output will fall, as aggregate demand is lower as people have less disposable income to spend, and so unemployment will rise.	

What is meant by stagflation?

This is where a level of high inflation, high unemployment, and slow growth all occur at the same time – the Phillips curve says this cannot happen.

What is NAIRU?

This is the Non-accelerating inflation rate of unemployment – the “natural” level of unemployment. If unemployment goes below this level, rapid inflation is likely to occur.

To what extent has the UK economy been consistent with the Phillips Curve in recent years?

Most recently, the UK has experienced very low inflation rates, and reasonable levels of unemployment, which is not consistent with the Phillips curve. However if we look further back, unemployment rates were very high in the late 1980’s recession, but inflation stayed around the 5.5% mark, which, although high, was close to that of other similarly developed counties in Europe, which would seem to support the Phillips Curve. 

How does the UK compare to other European economies in relation to unemployment and inflation?

It has a fairly low rate of unemployment, 5.4%, compared to France’s 9.1%, and Germany’s 8.4%, although it is not the lowest in the EU, as it is beaten by countries such as Norway, at 3.5%.
	The CPI puts the UK’s inflation rate at 2.3%, above France and Germany’s 2.0%, and on par with Norway at 2.3%. These figures seem to support the Phillips Curve, as those countries with high unemployment rates tend to have lower inflation rates, although it’s hard to say with only four countries.

Explain the relationship between growth and current account.

If a country is purchasing lots of goods and services from abroad, and producing little itself, it would seem that the country’s output is limited by this. A country such as China, which has an enormous current account surplus, also experiences a very high growth rate. This is because the country is producing lots of goods to export, and purchasing few imports (instead consuming domestically produced goods and services), thus increasing aggregate demand, and so output.