Reducing Inflation without increasing unemployment?

Question

i was wondering, is it possible to reduce inflation without increasing the unemployment level?

Answer 1

Yes it is. If you improve the supply-side of the economy eg. improve education, restrict trade union power etc Long Run Aggregate Supply will increase and ceteris paribus, inflation will fall along with unemployment.

     The relationship between unemployment and inflation has troubled economists for years. In the 1950's an economist at LSE proposed the Phillips curve which suggested a relationship between unemployment and inflation in the UK. He suggested that as inflation rose, unemployment would fall. However in later years this was effectively disproved. Milton Friedman suggested this was merely a short-run phenomenon.

     In the long-run there is no relationship between inflation and unemployment and any attempt to reduce unemployment will be ineffective and inflationary in the long run. This is because if a government allows more inflation in order to reduce unemployment, peoples expectations of inflation go up. This creates an inflationary spiral. In the long-run unemployment always tends back to the 'Natural rate of unemployment' or the NAIRU (Non Accelerating Inflationary Rate of Unemployment) as Friedman called it. So in the short-run if an attempt is made to reduce unemployment, this will happen with higher inflation. However in the long-run when unemployment returns to the natural rate, it will do so at a higher general price level.

     Therefore in order to reduce unemployment in a non-inflationary manner, the best way is to reduce the NAIRU. As mentioned before the way to do this is by improving the long-run supply side of the economy by increasing productivity in the economy or by increasing the population.

Hope that helps.

Answer 2

For decades until 1997 and the arrival of New Labour, it was accepted in political and financial circles that "full employment" could be defined as 3 or 4 per cent unemployed.  The argument went like this:



1 per cent due to structural changes in industry, as declining trades and crafts released labour,

1 per cent or more due to geographical differences and immobility in the labour force - unwillingness to move to areas of labour shortage,

1 per cent or more due to "stickiness" in the labour market as some people were between jobs; not able to move immediately from one job that finished to another starting.

The taxation and benefits system was designed to create a cushion for this 3 or 4 per cent, so that household income should not fall to unacceptable levels and aggregate demand be supported thereby.

Also, over the same decades, it was acceptable to most politicians and economists to have inflation at about 5 per cent per year.  The argument included rising costs of imported materials and services, excess demand for certain goods and services which may have been transitory, and an understanding that wages and prices should be allowed to rise over time as a measure of comparative international wealth and as an incentive to labour and industry.

These two acceptable policy targets worked together for many years, so that one may rise and the other fall from time to time, but the overall balance seemed capable of being maintained.  The theory seemed true that inflation is caused by excess demand and unemployment is caused mainly by a shortage in aggregate demand.

Since 1997, there has been no unemployment target and inflation has been targeted at 2 per cent.  Unfortunately, the inflation target takes no cognizance of international costs and in recent months that has meant oil and food prices. Pre-1997, or even pre-Thatcher, a 2 per cent inflation rate would have been equated with 6 or 7 per cent unemployment, and that would not have been acceptable as a policy position.

Of the two, unemployment is the most damaging and pernicious.  Inflation affects everyone by a few percentage points, but unemployment affects only a few and they experience unemployment 100 per cent.  

The solution, if there is one, is to allow inflation in costs and wages to take effect, and to use raised taxation receipts to soften the burden of unemployment.  But this raises another historical question that New Labour have ignored for many years.  Public policy should have regard also to the balance of payments and to the national debt (government borrowing).  For some reason, the four strands of national economic policy have been disconnected since 1997, maybe since the closing days of Margaret Thatcher, and the full armoury of policy tools has not been deployed.

During the final Conservative adminstrations, government borrowing was reduced to very low levels and the accumulated national debt all but paid off.  There is no need for such an approach except to satisfy some notion of national pride or "good housekeeping".  Similarly, constantly seeking a balance of payments surplus is unrealistic and policy should be aimed at maintaining a balance over a long period.

If these two features of economic policy were to be considered alongside inflation control and reducing unemployment, then a wider range of tools becomes available and it would be possible to reduce unemployment whilst also preventing excessive inflation.  The cost would be rising government borrowing and a balance of payments deficit.  The Americans have lived with continuing external deficit for decades, and colossal net borrowing but, for some reason, the European Central Bank, regards these policy measures (or consequences) as unacceptable.  I think that points out the weakness of ECB, which is only an exchange rate fixer, not a lender of last resort and not very good at defining between-member economic policy.

Anyway, the answer to your question is "Yes", it is possible to reduce inflation without raising unemployment but is that what we should be trying to do?  I think we should be seeking to reduce the effects of unemployment without raising the rate of inflation.  There are policy measures to do so but neither Conservative nor New Labour is willing to use them.

Answer 3

it's all about expectations. the reserve bank should talk down inflation and talk up the dollar (or local currency). The only problem is that they could lose their credibility through bluffing. that is-lm stuff is bs.

Answer 4

Some years ago Kenneth Clark then Chancellor stood up in the House of Commons and stated 'Unemployment is a price worth paying to keep inflation down'.

With ministers like that completely out of touch with reality what hope do we have.

Answer 5

Yes... if you familiar with AD-AS analysis, shift the long run AS curve..

increasing capital stock and spent it to education, research and development, hence, there's a technological progress, and the economy will be more efficient... it means, to meet increasing demand for goods (which will inflate the price of goods), you don't have to increase the interest rate that will lead to unemployment, because firms can add supply because their technology in producing output is better than before..

Weakness: you need time not only months, but years...

Examples: World economy in the early 1990s. results from investments in research and development in the 1980s--> invention of computer, softwares (microsoft), new machinery, leads to efficiency --> inflation was low and under control, and unemployment decreased too..

Edit:

From the previous answer (i'm not attacking cornish granny), that quotes "unemployment is a price worth paying to keep inflation down" by the minister.. IMO, this is a stupid and illogical opinion.. economy is a science that study human behaviour, and its purpose is to give wealth and also happiness to its people (all of them)...

If people jobless, whether there's inflation or deflation, they can't buy any goods, because there's no source of income,  and, especially in developing countries that usually still don't have social and health security, it will makes their condition more severe than before..

Which one do you prefer? people can't buy any goods, or people's purchasing power decreases...

Answer 6

When inflation is used to create more employment by increasing borrowing and by increasing the money supply.  Then it's pretty hard to reduce inflation without decreasing the inflation-dependent employment at the same time.

But once you decrease the borrowing and the inflation associated with it.  Then it is possible to increase employment in a low inflation environment by decreasing the costs of services and production of goods through trade, innovation, and the use of technology.

Answer 7

It is possible through increasing productivity per employee.Efficiency of capital has to be improved by better technology.Avoiding wasteful expenditure,cutting down on advertisement and selling costs are other methods.It is possible,out put per employee is the key factor.

I knew one instance in Asia's biggest hawai chappals factory(Lunar).When it was inflation and rubber prices moving up they reduced the price of chappals.When i visited ,i found that employees volutarily increased their working hours by one hour and they replaced some machinery to improve production.