Trade Off Between Inflation and Unemployment
There can be no trade-off between inflation and unemployment whether in the short or the long run. Comment.
Inflation is a major challenge; the world is facing today and has become an impediment to robust growth. However, this problem is not new. In 1981, The Gallup Organisation in the US conducted opinion polls asking people, what is the most important problem, their country was facing, and a majority named inflation.
Although governments in different countries have been using policies to contain it, it’s not so simple. Lowering inflation may lead to a rise in unemployment which could act as an obstacle to economic growth.
This debate, whether there’s actually a trade-off between inflation and unemployment, has been puzzling the macro-economists for decades now, but we’ve still not been able to arrive at a concrete conclusion. Different schools of thought have their own viewpoints and their own theories to support those viewpoints.
In this paper, I shall discuss briefly, the different schools of thought and their viewpoints and try to unravel this mystery by amalgamating the different viewpoints.
I. ‘Old’ Classical school
The classical school including Adam Smith, David Ricardo, John Stuart Mill etc. that existed prior to the ‘Great Depression’, believed that the economy ultimately (in the long-run) reaches full employment. The disturbances, if any, would be temporary and very short-lived. There was no need for any countercyclical policy (whether fiscal or monetary) to boost the economy. According to them, there is perfect wage-price flexibility and thus, no possibility of involuntary unemployment. Their explanation was also backed by the well known ‘SAY’S LAW’, according to which, supply creates its own demand. Thus, whatever is produced will be demanded, and therefore economy is always at full employment. A ‘glut’ can occur, but only temporarily. Therefore, we get a vertical (almost) AS curve (and correspondingly, a vertical
Inflation is a major challenge; the world is facing today and has become an impediment to robust growth. However, this problem is not new. In 1981, The Gallup Organisation in the US conducted opinion polls asking people, what is the most important problem, their country was facing, and a majority named inflation.
Although governments in different countries have been using policies to contain it, it’s not so simple. Lowering inflation may lead to a rise in unemployment which could act as an obstacle to economic growth.
This debate, whether there’s actually a trade-off between inflation and unemployment, has been puzzling the macro-economists for decades now, but we’ve still not been able to arrive at a concrete conclusion. Different schools of thought have their own viewpoints and their own theories to support those viewpoints.
In this paper, I shall discuss briefly, the different schools of thought and their viewpoints and try to unravel this mystery by amalgamating the different viewpoints.
I. ‘Old’ Classical school
The classical school including Adam Smith, David Ricardo, John Stuart Mill etc. that existed prior to the ‘Great Depression’, believed that the economy ultimately (in the long-run) reaches full employment. The disturbances, if any, would be temporary and very short-lived. There was no need for any countercyclical policy (whether fiscal or monetary) to boost the economy. According to them, there is perfect wage-price flexibility and thus, no possibility of involuntary unemployment. Their explanation was also backed by the well known ‘SAY’S LAW’, according to which, supply creates its own demand. Thus, whatever is produced will be demanded, and therefore economy is always at full employment. A ‘glut’ can occur, but only temporarily. Therefore, we get a vertical (almost) AS curve (and correspondingly, a vertical