Question

A) Under what circumstances might it be possible to reduce inflation without causing a recession?

B) Explain two ways in which a recession might raise the natural rate of unemployment.

Answer 1

(A) If we reduce production costs, prices will not rise and inflation will be stopped. It is possible when new technologies are implemented in production process. Also these technologies create new working places (employment) and increase level of production (GDP), so there will not be recession in economy.

(B) One way in which a recession might raise the natural rate of unemployment is by affecting the process of job search, increasing the amount of frictional unemployment. For example, workers who are unemployed lose valuable job skills. This reduces their ability to find jobs after the recession ends because they are less desirable to firms. Also, after a long period of unemployment, individuals may lose some of their desire to work, and hence search less hard.
Second, a recession may affect the process that determines wages, increasing wait unemployment. Wage negotiations may give a greater voice to “insiders,” those who actually have jobs. Those who become unemployed become “outsiders.” If the smaller group of insiders cares more about high real wages and less about high employment, then the recession may permanently push real wages above the equilibrium level and raise the amount of wait unemployment.

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