Question

“Inflation is caused by tightness in labour markets, so policy should be oriented at
inducing unemployment to bring down wages.” Critically discuss.
Word Limit – 750

Answer 1

In any economy, inflation is said to have taken place, when the general price level in the economy has been such that it has been increasing over a stipulated number. For example, inflation rates in the United States are accepted at 2% meaning, that a 2% increase in the general price levels is considered normal. However, inflation beyond this is bad for the economy as the price of goods and services change rapidly.

It is believed, by some that creating unemployment in the economy would solve the problem of inflation by reducing the money in circulation.

However, the reality is that unemployment in itself will not reduce inflation rates. This is because if the money in circulation still remains high, the net effect of unemployment would be short lived. Further, a reduction in demand is possible through other means also. Unemployment is bad for any economy seeking growth. The key is to be able to create jobs on one hand, and on the other ensure that the level of money in circulation is limited.

Unemployment may seem to control inflation but cannot be used as a policy tool, as it makes purchases difficult for people who have no money left. If inflation still remains these people would never be able to purchase goods and services, and the living standards of the country would be impacted deeply.

There are other ways, in which a country can manage inflation which are by increasing interest rates that provide higher returns on savings, and increasing tax slabs which allow people to earn more and yet the government reduces the flow of money in circulation.

Due to the possible downside of unemployment being that it creates recession in an economy in which numerous people are never able to purchase goods, and the supply side may also take a hit, alternative measures including the above, are used to counteract the same. It is not advisable to reduce the number of jobs, as it grossly impacts the productivity of a nation. As far as possible other means should be evaluated and used.

Please feel free to ask your doubts in the comments section.