Falling Inflation Amid Rising Unemployment

Context

In May 2025, India witnessed a significant fall in inflation to 2.8%, yet unemployment rose to 5.8%, highlighting a complex economic scenario where price stability coexists with a weakening job market. This paradox raises critical questions about the interplay between inflation and unemployment and the broader implications for economic policy.

Recent Economic Trends in Inflation and Unemployment

• Inflation Decline: The sharp decline in inflation, especially food inflation which dropped from nearly 11% in October 2024 to less than 1% in May 2025, was primarily driven by faster agricultural growth. Increased food production narrowed the supply-demand gap, easing price pressures and pulling down the overall Consumer Price Index (CPI).
• Rising Unemployment: Contrasting the inflation trend, unemployment rose from 5.1% in April to 5.8% in May 2025. This increase was largely due to a post-harvest seasonal slowdown in agriculture, which caused a fall in agricultural jobs from 45.9% to 43.5% of the workforce. The rise in unemployment was especially pronounced among youth (urban youth unemployment at 17.9% and rural youth at 13.7%) and women, whose labour force participation rate dropped from 28.8% to 27.8%.

Understanding the Inflation-Unemployment Relationship

• Phillips Curve Context: Traditionally, the Phillips Curve suggests an inverse relationship between inflation and unemployment—lower unemployment tends to push inflation up, and vice versa. However, the current scenario challenges this notion as inflation falls while unemployment rises.
• Demand-Side Explanation: The rise in unemployment typically signals a fall in aggregate demand (AD) and economic growth. Lower demand reduces wage pressures because unemployed workers weaken the bargaining power of labour unions, leading to muted wage inflation. Firms also face higher spare capacity, increasing price competition and further lowering inflation.
• Cost-Push Inflation Complexity: Sometimes inflation and unemployment can rise together due to cost-push factors like oil price shocks. However, in India’s current case, the fall in inflation alongside rising unemployment suggests demand-side factors dominate.

Why Inflation Fell Despite Rising Unemployment

• Agricultural Growth: The faster growth in agriculture increased food supply, which is a major component of CPI, thus driving down inflation despite weak demand in other sectors.
• RBI’s Monetary Policy: The Reserve Bank of India (RBI) did not raise repo rates since June 2022, yet inflation fell sharply. This indicates that inflation dynamics were influenced more by supply-side factors than monetary tightening. The RBI’s inflation control strategy appears reactive rather than proactive, with inflation expectations remaining high despite actual inflation falling.

Implications of Rising Unemployment Amid Low Inflation

• Economic Growth Slowdown: GDP growth slowed from 9.2% in 2023-24 to 6.5% in 2024-25, reflecting a broader economic slowdown that impacts employment generation.
• Sectoral Shifts and Labour Market Challenges: The post-harvest decline in agricultural employment and insufficient absorption of labour into manufacturing and services sectors contribute to rising unemployment, especially among vulnerable groups like youth and women.
• Labour Force Participation: The drop in female labour participation indicates persistent structural issues in the labour market, exacerbated by seasonal and economic factors.

Policy Considerations and Way Forward

• Balanced Focus Beyond Inflation: Focusing solely on inflation control can mask deeper economic problems such as joblessness, which directly affects livelihoods and social stability.
• Monetary and Fiscal Coordination: Monetary policy needs to be complemented by fiscal measures that stimulate demand and create jobs, especially in non-agricultural sectors.
• Structural Reforms: Enhancing skill development, promoting labour-intensive industries, and improving labour market flexibility are essential to absorb the growing workforce.
• Monitoring Inflation Expectations: Persistent high inflation expectations despite falling inflation suggest the need for credible communication and policy frameworks to anchor expectations and support economic stability.

Conclusion

The simultaneous fall in inflation and rise in unemployment in India during May 2025 illustrates the complex and sometimes counterintuitive relationship between these two key economic indicators. While supply-side improvements in agriculture helped tame inflation, the labour market remains fragile due to seasonal and structural challenges. Policymakers must adopt a holistic approach that goes beyond inflation targeting to address unemployment and ensure inclusive economic growth.

 Source: The Hindu

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