Question

1. Please critically analyze the following statements.

Inflation and unemployment are costly and harmful to the economy and society. As such, they should be avoided at all costs. Stabilization policy for the purpose of promoting a zero rate of unemployment and inflation should be developed and implemented.

2. Developments in labor markets are critical to understanding inflation. Some argue that when labor markets are “tight”, wage increases will cause inflation. Is this a necessary result? Please explain in detail.

Answer 1

1.

Inflation and unemployment are two of the most important indicators of the economy. An inflation in the economy at a moderate rate, is always a reflection of increase in demand that is pushing the firms to increase the supply. An economy always tries to achieve natural rate of unemployment that means that there is always a structural and frictional unemployment in the economy even if the economy is expanding. Hence, it will not be right to say that inflation and unemployment should be at zero %. A zero inflation will create more harm than the moderate inflation as it is the indication of recession coming and people have gloomy expectations about economy. It makes inflation to zero and even negative. It will make more harm than the good. A zero unemployment will eliminate structural and frictional unemployment when there is an inflationary gap. In this case, there will be demand pull inflation and economy will suffer. Price will also rise. It is the reason that central banks such as Fed sets inflation rate target around 2 – 3% and unemployment at natural rate of unemployment of 4 – 5%. It brings a regulated growth of the economy and household income increases. Further, in the long run, the real output is not dependent upon the price level. So, stabilization policy should not intend to achieve 0% of the inflation and unemployment. Rather, the policy should help economy grow with a consistent rate.

Pl. repost other unanswered questions for their proper answers!