Question

Given that labor is a resource that needs to be used efficiently, what responsibility do you feel the government has in decreasing unemployment? Does the negative relationship between inflation and unemployment have any impact on your decision?

Answer 1

In any society labor needs to be used efficiently otherwise higher unemployment will result to the standard of living being lower than what would be if labor was used efficiently or unemployment was low. This directly translates into being on the production possibility frontier(PPF) compared to being inside it, which is inefficient.

Higher unemployment can also lead to other tangible ramifications like, increase in people requiring social security benefits. This will lead the tax revenues-which would anyway be less because of more unemployment- to get diverted from other government programs to meet the needs of the unemployed. It has also been seen that high unemployment leads to more drug and alcohol abuse in society. Therefore it has a social cost that the government has to take responsibility for.

While reducing unemployment there is another consequence that needs to be taken cognizance of i.e. higher inflation. Although this inverse relation hasn't been always found to exist, or in other words, hasn't always held to be true, but it many cases the trade-off does exist like in the 1980s and 1990s when high inflation was moderated because of a recession inadvertently. Governments in the past have tried to exploit this trade-off, but haven't always been successful like since 2012 the US government has tried inflation targeting at 2%, but the inflation has always been below that as well as unemployment (lowest in past 15 years) . Nevertheless, it should not be ignored.

The government may use different monetary or fiscal policies, or a combination of both to tackle unemployment. Suppose the government reduces unemployment by exercising a fiscal stimulus, this will lead to high inflation. If the inflation rate is higher than the interest rate that people get by saving their money, then the people who rely on the interest income from their savings will be poorer, which will be undesirable.

Higher inflation puts more pressure on the government to increase the value of the pension and unemployment benefits as the cost of living goes higher. But for those individuals who are not able to hedge against inflation will be left poorer.

Therefore, single-mindedly pursuing reduced unemployment can lead to undesirable outcomes.