Sep 04 2008

The Federal Reserve and the tradeoff between unemployment and inflation

Federal Reserve sees slow economy, higher prices – Sep. 3, 2008

Weak aggregate demand and rising costs due to still high energy and food prices put the US economy in a tricky situation, one in which the Federal Reserve is forced to make the tough decision between tackling the unemployment problem (jobless rates have risen to 5.7%) or the inflation problem (price levels have also risen 5.7% this year, the highest inflation in 17 years).

The nation struggled with slow economic growth and still-high prices that are weighing on consumers and businesses alike…

Fed Chairman Ben Bernanke and his colleagues are all but certain to leave a key interest rate alone at 2% when they meet next on Sept. 16 and probably through the rest of this year.

Given the fragile state of the economy, the Fed isn’t in a hurry to boost rates to fend off creeping inflation. A growing number of analysts believe the economy is likely to hit another dangerous rough patch later this year as consumers and businesses curtail their spending even more.

Heading into the fall, economic activity continued to be slow, the Fed said. Businesses described the climate as “weak” or “soft” or “subdued.”

Consumers, the lifeblood of the economy, showed caution. Shoppers “concentrated on necessary items and retrenchment in discretionary spending,” the Fed observed.

In the short run, as year 2 IB students know, society faces a trade off between high inflation and high unemployment. Rising prices and rising joblessness are both harmful to the economy, but when energy and food prices drive up the price level, while week investment and consumer spending lead lead to falling overall demand in the economy, the conditions exist where joblessness and prices can rise simultaneously. This is America’s situation at present.

The Fed must chose which problem to address. Ben Bernake, America’s central bank chief, could chose to tackle rising inflation by raising interest rates, which would discourage new investment and reduce demand for resources by firms in the economy. Investment spending by firms and consumption by households would decline, putting downward pressure on prices across the economy.

In the short-run, however, the decline in investment and consumer spending that would result from higher interest rates would exacerbate the already weak level of aggregate demand in the economy, driving unemployment even higher.

By keeping rates low, Bernanke hopes to encourage investment and consumption, which will contribute to overall demand in the economy. By encouraging new spending and investment, however, the threat that inflation will rise even more remains present.

In the trade off between unemployment and inflation, the Republican White House and the Democratic Congress made it clear that unemployment was the most important problem to address when they announced the $160 billion expansionary fiscal stimulus package earlier this year. By keeping rates at a low 2%, America’s central bank is also indicating that increasing employment is of greater importance than lowering the price level.

Discussion questions:

  1. Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
  2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
  3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said.
    If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

240 responses so far

240 Responses to “The Federal Reserve and the tradeoff between unemployment and inflation”

  1. cameron7on 03 May 2013 at 8:59 am

    #stak

    Good answers, I thought they were concise but accurate. I just have to add something for your answer to the first question, where I do agree with you,but additionally, it will create higher demand for loans and an increase in consumption. This will have the firms making more money since they are going to be supplying a lot to please the high demand. Therefore, they will be maximizing profits and revenue, which can ultimately cause them to expand their firm and decrease unemployment.

  2. nikolay@pamojaon 03 May 2013 at 8:07 pm

    1. low interest rates would allow firms more freedom when attempting to increase their factors of production thus increasing their supply capabilities.
    2. I believe that employment is more important to policy makers as the population believes that employment is more important. The fact that it is an election year does matter greatly. Basically the primary motive for a politician is to please as may people as possible, if that means decreasing unemployment then that is what they will do. One could also make the argument that the increase in price of living is not as bad as the increase of people who cannot afford to live at any price. But then on the other hand if price of living continues to increase no one will be able to afford living even if everyone is employed.
    3. If wages continue to rise, and unemployment continue to rise, then nothing would self correct because at the end there would be no one employed or one person with a wage that is the GDP of the USA. But assuming the question means is it a good idea to increase the wages of certain employees while others are being fired? The answer is no, however one could just have a chat with Keynes to understand that wages are sticky on their way down, and sometimes are so sticky that they move up despite it clearly not being the time for that.

    @#cameron7
    I like how you added such depth to the answer you were replying to while still focusing on the asnwer and providing constructive criticism. Just a wonderful responce.

  3. lannison 04 May 2013 at 6:40 pm

    1.Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    It is true that low interest rates are a demand-side policy. This increase in demand would result in firms be able to loan money and to purchase long term benefiting capital goods such as newer technology, equipment, labour. All of these resulting in a positive supply-side effect.

    2.Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    As stated in article, consumers are the life blood of the economy. Without the consumer, the economy fails. We can only have consumers if they have money that they can spend, and to receive money they need a job. Thus, employment is the foundation for successful economies. Inflation can then be targeted later on by implementing fiscal policies. An election year would matter. Many ordinary people think the unemployment is the biggest issue, and there are millions of unemployed Americans. If a presidential candidate were to focus his/her campaign on employment, he would most likely win the votes of those unemployed and those who believe unemployment is key.

    3.“Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    I can’t say that the economy will ultimately correct itself into a state of equilibrium, however, it would help itself. Since prices are becoming to high and there are many people with jobs (thus have no money to consume goods), the demand for goods would decrease. This would subsequently lower the price of the goods. As people begin consuming again, the firms would need to compensate for this increase in demand by hiring more labour workers, decreasing unemployment.

  4. lannison 04 May 2013 at 6:50 pm

    #Monique T

    Great answer to question 1. It was short and right to the point. It didn’t go around the question using unnecessary details and vocabulary.

  5. clundon 06 May 2013 at 1:10 pm

    1. By lowering the interest rates firms will be more likely to invest in new factors of production, like new machines or increase the labor skills of their employees to become more efficient or simply just employ more (which will decrease unemployment). This will lead to an increase in output and move the aggregate demand curve to the right and will therefore lower the price level.
    2. He fact that it’s election year definitely matters –it’s no incidence that the business cycle in general last 4 years. When people vote they choose the candidate who will improve their lifestyle the most, so to focus on lowering inflation will not only make you loss the unemployed votes but also increase this group of people, which is a bad strategy if the policy-makers want another round which they normally do.
    3. I think that it’s unlikely that the US economy will self-correct after it has interred this dark spiral. By keep un raising the wages the business pushes up inflation, which mean that their cost of production will increase as well, which will force them cut jobs. If this rise in wages is the primary course of the inflation it’s quite likely the government who will have to stop it since the employed won’t agree on having their wages lower/locked while prices are still increasing. This could be difficult though because of labor unions which will try to fight against the government policies such as price wage ceilings.

  6. clundon 06 May 2013 at 1:24 pm

    #cameron7

    Hi Cameron, your answers are good and detailed. Just something to think about: what will happen to the aggregate supply curve at the situation that you very well described in 1?
    For 3, why could it be that the government hadn’t done anything about the stagflation yet (maybe something to do with sticky wages) and what could they do?

  7. skangon 06 May 2013 at 6:47 pm

    1.
    -Low interest rates result in people borrowing more money from banks. As a result, they have more cash and demand increases. When demand increases, people want to fill that demand and thus supply increases, bringing about positive supply-side effects for the economy.
    2.
    -Depending on the election year, increasing employment’s priority can change. All policy makers do not want to lose their jobs and as a result they realize that public sentiment is very important. Unemployed people are unhappy people. Unhappy people will not vote for incumbents.
    3.
    -It would not correct itself because eventually, everyone would be unemployed and thus the economy would slow down even further.

  8. skangon 06 May 2013 at 6:48 pm

    # nikolay@pamoja
    I agree with your answer to 2. The population believes that unemployment is more important than inflation and as a result, policy-makers will work to combat unemployment more than inflation in order to keep the public happy.

  9. nwarneron 06 May 2013 at 7:24 pm

    Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    By lowering the interest rates firms will invest more in factors of production such as new machines or increased education for the labor to increase their skills to create more efficiency. This can lead to an increase in output of the product that is produced which will cause the average demand curve to shift to the right thus lowering the price.
    Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Employment is a more important consideration for policy makers as unemployment tends to have a more negative effect on individual workers than inflation does. This is amplified if it is an election year as the workers and people will determine the election. Since high unemployment is more unpopular than high inflation the politicians would try to solve the unemployment at the cost of inflation. Also the consequences of unemployment tend to be more visual than the consequences of inflation. For example, a person living on the street starving and struggling to feed themselves than the loss of competitiveness of domestic industry. However, depending on the political ideology the reduction in inflation could be viewed as more important.
    “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    It is likely that the market will self-correct. As wages rise even if unemployment is falling than the aggregate demand of the economy will raise this will cause prices to rise. This inflation if you follow the Phillips curve than you’ll believe that the high inflation will lower the unemployment. Personally I believe that the high prices will cause there to be high profits which if there are limited regulations the businesses will invest to increase operations which will slowly create new jobs. The economy will then return to the full employment.

  10. nwarneron 06 May 2013 at 7:24 pm

    # lannis
    I like your answer to the second question. It is very detailed and describes the economic and political consequences well. I agree that politicians focus on getting the work of the unemployed. However, I disagree that if you fix unemployment than you can control inflation through fiscal policies. I think that at its core the inflation rate is difficult for the government to control besides through the control of the fiat currency. Therefore it is hard for a politician to control the inflation rate as the central bank can normally better control the inflation rate.

  11. jyoungon 06 May 2013 at 11:30 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    Lower interest rates can encourage investment by firms in their own factors of production leader to newer equipment, technology, and efficiency, resulting in more output by individual firms and more aggregate supply at the same or lower price level.

    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Unemployment is seen by policy-makers and more important because it hits individuals and the public harder than inflation does, whether we look at the rational or irrational reasons. Unemployment can have greater consequences than inflation and also decrease AD relatively more. In the US the government also has to pay jobless benefits to those out of work. The fact it is an election year does matter to an extent because voters a looking for a leader who is able to come up with policy that aids what is most important to them, and many times this is unemployment.

    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    The US economy would self-correct, it would just take much longer without any different central bank or government policies. This is because wages would not continue to rise as unemployment rose because of the free market forces of supply and demand. With a large supply of workers firms to not have to increase wages to compete for workers, eventually they will have to lower them, this will cut costs and firms will be able to employ more labor.

    -jyoung

  12. jyoungon 06 May 2013 at 11:35 pm

    #nwarner

    I agree with your view that the US economy is likely to correct. In this scenario it is not as much a matter of if, as when. Naturally it would take many different factors for an economy to come out of a recession or downward term, and if government policy is in place that negatively effects the economy it needs to be removed or replaced. Depending on the policy in place it can be harder for an economy to self correct with the government limiting it.

    -jyoung

  13. tleeon 07 May 2013 at 4:50 am

    Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    Lower interest rates can encourage more firms to borrow more money. The money can be used to improve technology, hire more workers, and ultimately produce more. Also consumers will also borrow more money to spend which means that the firms will have to meet the higher demand so they will have to produce more.

    Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Increasing employment is a higher priority for policy makers because unemployment affects the individuals. The government doesn’t want unemployment rates to be high because this will negatively affect the AD of the economy. It does matter that its an election year because people want to make more money. So they will want to elect someone who will give them more job opportunity and compared to dealing with the inflation rate, increasing employment will appeal to the consumers more.

    “Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    It will take a long time until people can see any improvements in this ridiculously bad economy. However, because there are less income made, people will have to consume and spend less. This means that the prices of goods will have to decrease in order to meet the small demand. Once demand becomes stabilized, the firms don’t need to worry about supplying more because there is such a large amount of unemployed people looking for work that the wages will never rise. As long as there are a good percentage of people that are willing to work for minimum wages, the wages will never increase.

  14. tleeon 07 May 2013 at 4:53 am

    To #jyoung

    I liked how you mentioned that the wages will not increase as unemployment rises. Your answers were very clear. Very good analysis. I also agree with when you said that people are looking for a leader that will basically provide them with jobs, so they will vote for a leader who will lower unemployment.

  15. aleeon 07 May 2013 at 6:47 am

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Lowering interest rates will result in positive supply-side effects for the economy because firms will be able to invest in more sophisticated technology or improve their current machinery to increase their output.

    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Increasing employment may be a higher priority to policy-makers because if employment increases, more consumers will receive a higher income. If there is an overall higher income to consumers, consumption will increase. Bringing down the inflation rate is not very significant if a person has no income to begin with. It might matter more if it is an election year since policy-makers will try to please the public so that they can be reelected.

    3. If wages continue to rise even as unemployment rises, is it likely that the US economy will every “self-correct” from in times of an economic slowdown?
    No, it is not likely that the US economy will self-correct itself. If unemployment continues to increase, more people will have a lower standard of living. They will not be able to consume goods and services, and this will stunt the economy.

  16. aleeon 07 May 2013 at 6:52 am

    Hello #tlee!
    I completely agree with what you said about people wanting to elect the policy-makers that give them more job opportunities. Good observation!

  17. Yada Pruksachatkunon 07 May 2013 at 3:06 pm

    1) Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    As many have said before me, lowering interest rates equate to less value in borrowed money, and therefore, firms have more incentive with borrowing loans from banks. The newfound money can be used in Research and Development, which can in turn create technology breakthroughs in the production of a good or service. This will then create the aggregate supply curve to shift to the right, and inflation will decrease. However, even if there is no technological breakthrough, the increase in money will make it possible for firms to hire more labor (factor of production) and decrease unemployment.

    2) Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Unemployment is a worse evil than moderate inflation (as the US’ inflation rate is still lower than the double digits and is not yet considered hyperinflation) because it leaves a downward spiral where aggregate demand goes down, and unemployment increases. The government would need to increase their budget for unemployment benefits. Also unemployment leads to an increase in crime rates and depression, and the economy is not operating at full capacity. I do think that the factor of election year matters, as less unemployment will mean a less depressed population. Also, because candidates are trying to appeal to as many different demographics as possible, it is crucial that unemployment goes down (to signify the “every man should have the right to work”) and “equal rights” air that surround every election.

    3) “Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    I think it is likely that the US economy will self correct. Times like these are called “Stagflation,” or when a supply shock sends inflation rocketing, but there is not enough aggregate demand, and consumers and firms are not given an increase in real value of their money to compensate for the inflation. Therefore, firms are forced to lay off employees, and unemployment shoots up as well. Every time the US has been in a period of stagflation, during the 1970s, and during the 2000s, the US has recovered. Why can’t they do so again? The government will most likely have to enforce market-based supply side policies such as getting rid of minimum wage and trade union power in order to increase the demand for labor.

  18. rparsonon 07 May 2013 at 4:24 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Lowering interest rates might lead to greater investment in factors of production and R&D on the part of firms, which will improve the supply side.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Because inflation is more of an insidious threat which is not really visible until hyperinflation begins to set in, voters are not likely to be concerned by it. However, unemployment is a very immediate and visible problem for most voters, and thus a solution to this is more appealing to politicians seeking reelection.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    If wages and unemployment both rise, this may be indicative of unemployment taking place among those who are less qualified for the job opening which exist, with the few qualified people being in high demand for companies. In the long term, education will increase the number of people qualified to do modern jobs and those who are unqualified will leave the workforce, decreasing unemployment. Also, those who do have higher wages are more likely to spend, helping the economy to recover. Absent incorrect intervention by government, an economy will self-correct.

  19. rparsonon 07 May 2013 at 4:26 pm

    @jyoung,
    I agree with your answers.

  20. Mkhosoon 07 May 2013 at 6:34 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Lower interest rates decreases the cost of borrowing for firms and thereby encourages greater borrowing by firms. This borrowed money is then used by firms to conduct capital investments to maintain or expand a firm’s capital base, allowing the firm to expand in size and increase its production.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Politics is a people game. It therefore follows that you win in politics by winning people. People are easily won over in election years by populist short term bonanzas and short-term economic boosts. One of the most visible of these ‘short-term boosts’ is reducing unemployment. It is easily and clearly seen, and very variable. Why is it that many government ministries usually add employees in the run up to elections? Why is it that governments prefer huge unsustainable stimulus packages in the short-term, which only delay the inevitable and painful economic rebalancing? Why is it that most governments are brought down through revolutions incited by the unemployed? Think Egypt, Tunisia, indeed, think the entire Arab spring.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    The economic situation is a clear example of ‘stagflation,’ a phenomenon in which unemployment and inflation are both simultaneously high. It is highly unlikely that the US will ‘self-correct’ in the current economic climate, as the serious fiscal imbalances in the economy are so deeply ingrained within the system that it will require a radical economic rebalancing to correct the system. This radical rebalancing can only be led by policymakers, it cannot be ‘automatic,’ the economy cannot simply ‘self-correct’ such tremendous imbalances. These imbalances include a ridiculous and unsustainable debt burden, highly concentrated wealth, economic inequality induced by geography, a weak education system and so on.

  21. Mkhosoon 07 May 2013 at 6:45 pm

    @rparson

    You state that rising unemployment and rising wages is synonymous with greater concentration of skills among a falling percentage of the population. However, doesn’t something similar already occur? Often, technology firms will poach ‘high-flyers’ from other firms to work in their companies for huge salaries and bonuses. Is it not already common for ‘high-flyers’ with a certain ‘elite’ skill set to be paid at a wholly different level from the common man? Think sports, finance and so on.

  22. alessiaayoubon 07 May 2013 at 7:02 pm

    1) Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    Lower interest rates, as mentioned, increase business investment and consumer expenditure or consumption since it’s now cheaper to borrow money from the bank. Increased levels of investment in the factors of production (labour, capital, raw materials, and even enterprise) contribute to an increase in productivity and thus an increase in overall output, meaning that the aggregate supply curve of an economy shifts to the right. This is certainly regarded as a positive supply-side effect. Given that lower interest rates also increase consumer expenditure, producers will be more inclined to produce more (further increase their output/supply) in response to an increase in demand in order to maximize their profits and utility. This is another positive supply-side effect triggered by lower interest rates, a demand-side policy.

    2) Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Policy makers should be more concerned about reducing inflation, rather than unemployment for several reasons.First of all, inflation affects the ensemble of the economy, and therefore has more significant impacts on a nation’s economy.
    During inflation, especially for individuals in a society whose wages or savings are fixed and not adjusted to inflation, purchasing power will decrease since real wages are reduced. The value of savings is also reduced. The overall loss of purchasing power reduces living standards, and generally creates unrest amongst the labour force who will opt to receive wages and salaries adapted to inflation. This will increase the costs of production, shifting the aggregate supply curve to the left, thus increasing prices, and causing further inflation and unemployment. The depreciated value of savings will discourage investment, and lower purchasing power will also do the same. Increased interest rates in attempts to reduce inflation and in order for banks to maintain their profits in real rates further decreases investment, and thus shifts the aggregate supply curve to the left, raising average price levels further. An inflationary spiral occurs. Unless inflation is reduced, the economy in question would only experience progressively slower growth.
    National exports will become less competitive internationally at higher prices, and demand for imports, cheaper (from countries with lower inflation rates) will increase, therefore increasing the leakages in the circular flow of income in the economy, and decreasing national output/income. This may lead to unemployment, not only in export industries as is China’s case, but in other industries as well. By establishing policies which fight inflation, economic policy makers are also likely to indirectly reduce unemployment.
    Unemployment comparatively does not trigger costs which are as devastating economically as does inflation. The costs of unemployment for example are lower living standards of the unemployed, higher crime rates, loss of tax revenue for the government, and increased government spending in the form of unemployment benefits. Note that all of this deals only with a minority of the population in an economy.
    In conclusion, the greater costs of inflation suggest that it should be of greater concern to economic policy makers than unemployment, although a balance between both is amongst the desired macroeconomic objectives.
    Moreover, I do not believe that this prioritization should change during an election year bearing in mind that it’s in the candidate’s greatest interest to opt for more stable rates of inflation in their economies in order to gain more political support.

    3) If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    Unemployment and inflation, the two evils of any economy, when occur simultaneously along with a lack of growth in consumer demand and business activity, are described as stagflation. This is certainly an unpleasant state for any economy to be in since policy-makers are faced by the trade-off between unemployment and inflation. Aggravating the confusion in this decision is the fact that it’s very difficult to determine which type of inflation and/or unemployment is in question, thus making the choice of policies to implement tricky. Is it possible for an economy to self-correct from this situation? Following the neo-classical LRAS approach, self correction is possible in the long run as the economy will always return to the full employment level of output. However this only happens in the long run, a situation which only comes to be after much suffering from both inflation and unemployment. Moreover the time lag after which this full employment state is achieved varies with the rates of inflation and unemployment. Following the Keynesian model, government intervention would certainly be necessary in order to limit the consequences of both inflation and unemployment on the economy and society in question to the minimum, and also to reduce their duration. This can be done through the administration of both demand and supply side policies. For example, the government may run a budget deficit to increase its spending in efforts to reduce unemployment, also done through the implementation of supply-side policies aiming to increase a nation’s potential level of output. Interest rates may be raised (a monetary demand-side policy) which is the best way to counter inflation. A certain rate of inflation may also be set as a goal by the central bank in order to ensure price stability.

  23. alessiaayoubon 07 May 2013 at 7:07 pm

    # Mkhoso
    Very good answer but I think you should elaborate a little on question 1! :)

  24. Yada Pruksachatkunon 07 May 2013 at 9:20 pm

    Comment to #tlee
    I like your response to the first question; I completely overlooked the impact of cutting interest rates for consumers.
    However, for your response to the second question, could you explain a bit more about the “individual” effects of unemployment, and why those effects are more severe than those of inflation. Inflation also has many individual consequences, including a decrease in real value of money.

  25. rkangon 08 May 2013 at 3:18 am

    1.Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    – Low interest rates will ultimately lead to a increase in investment and consumption because low interest rates promote borrowing money. Most of the time firms and smaller consumers borrow money to spend it on a good or service. But if the demand for certain goods and services increase, the supply will also have to increase. Ceteris Paribus. Firms would try to increase their supply so that they can sell more products to the consumers that are willing to pay.
    2.Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    – Many times candidates try to make it seem like they can fufill all of their promises. Most of what they say is to gain popularity from the populous so that they can win the election. There may be some things that the candidate sincerely believes but a large part is to get the people to vote. Hypothetically, lets say the unemployment rate of country A is 10%. If a candidate appeals to the 10% of the people that are unemployed, then he will have a 10% advantage over the other candidates. I also think that unemployment can lead to higher rates of inflation. If less people are working, then the supply of goods and services will decrease. This means that firms are looking to sell their limited supply of goods for a higher price.
    3.“Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    – It is possible that unemployment rates can subside over time. As wages increase, unemployed people would have a motivation to seek a job to earn money. This is much like the long term equilibrium showed in the Neo-Classical long run equilibrium chart. There will be a sudden decrease in unemployment as the wages hit a certain price that is high enough to attract people into the work force.

  26. rkangon 08 May 2013 at 3:30 am

    #mkhoso
    It is very interesting to see how election candidates use the problems of the economy to boost their appeal to the people. They somehow manage to get the problem of unemployment and use that problem to create more of a “fan base”. Personally I feel that people should be wary of all the things that the candidates say. They shoud realize that some of the things they could be promising is only for the sake of getting more voters. So in times of an election, people seem to be the most optimistic about the problems of the economy.

  27. dtumanavarroon 09 May 2013 at 3:05 am

    Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    The low interest rates will increase firm investments and borrowing money which will allow them to maintain there supply with increasing aggregate demand. Lowering interest rates will also convince firms to start producing or working more within the country instead of where it is usually cheaper (china). The increase reliability of firms in their own country will open up new job opportunities etc it their own country. (Investing in your own country). The creating of new jobs within the country will employ more people.

    Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Their are many reasons that policy makers are more concerned in the primary than the latter. The first and weaker argument for this is that increasing employment will more likely bring down inflation than bringing down inflation increases employment in the short run. Also, supply-side policies tend to be more effective when it comes to cost-push inflation. But most importantly, to gain popularity. People are more likely to see a rise in employment than lowering in inflation and setting up fiscal policies never made a political party popular.

    “Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    Yes, I believe that every economy will eventually self correct itself. It would not be an easy time frame, and it could be very long, but every economy has eventually fixed itself or changed into a new market.

  28. ykim3on 10 May 2013 at 1:33 am

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    Lowering interest rates will help businesses to borrow money with cheap prices. The companies would be able to invest the money and develop or produce their products. This would improve producing ability and increase aggregate demand.

    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Unemployment has huge impacts on people. People can sese that they are going to lose or gain their jobs. Employment rate is a good thing to raise the popularity.

    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising
    inflation worries. Wary employers have cut jobs every month so far this
    year and aren’t inclined to be overly generous in their compensation to
    workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    As wages increase, unemployed people can be motivated to find the jobs for their lives. There will be a decrease of unemployment rate when the wages of workers become higher enough to attract people to work.

    #rkang
    You made a same argument that the change of wages will effect the unemployment.

  29. edubison 10 May 2013 at 3:42 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    The lower interest rates lead to higher investment and consumption, which then results in positive supply-side effects because firms will be able to purchase goods like new technology, equipment, or increase workforce.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Increasing employment should bring more capital into the circular flow of income. More money circulating in the economy will provide policy-makers with a greater audience and if the campaigners focus on this then they are likely to get votes of the lower income groups and unemployed.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    The US will probably try to put policies in place to decrease unemployment and encourage firms to hire more people even if they lower wages. This, however, isn’t self-correcting, so if there becomes an increase in small, or odds-and-ends jobs, then the economy may self-correct, but I don’t believe the economy will “right itself” without help from policies in this economic slowdown.

  30. edubison 10 May 2013 at 3:49 pm

    # dtumanavarro
    You think that every economy will self-correct itself, yet didn’t give solid evidence that this has happened or will happen. You say that “every economy has eventually fixed itself or changed into a new market,” but doesn’t the government usually intervene to make the general public satisfied enough not to rebel or protest? For an economy to correct itself, specifically the US economy in its “downward spiral”, the majority of the population will have to want change and e willing to change, no easy feat.

  31. amcpikeon 10 May 2013 at 10:21 pm

    Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    As stated above it is evident that lowering interest rates is a demand side policy, as it would increase both investment and consumption. However if we look at what low interest rates translate into practically we can see that it would become cheaper for firms to take out loans increasing their stock of money. This surplus of funds could lead to greater investment in research and development, consequently increasing productive efficiency and impacting the production sector of the economy. This would likely shift the Aggregate Demand curve to the right and decrease inflation levels alongside unemployment levels.

    Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Increasing unemployment is to a certain extent more dangerous than inflation. This is because unemployment damages a nations morale to a greater extent than inflation does. However a low morale is not the only reason that policy-makers should be aware of rising unemployment levels, as they also generate a host of other issues viz. black markets. The fact that it is election year only serves to aggravate the morale issue. This is because candidates will likely be proposing methods for decreasing employment would have massive impacts on both the number of voters, and who they are voting for. Inflation levels -which are less evident and consequently affect the psyche less- could be tackled once the candidate was in office by implementing new fiscal and monetary policy.

    “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    Unemployment and inflation working in tandem often signal a period of what is colloquially known as “stagflation” when they are accompanied by a period of decreasing consumer demand. Unfortunately for policy-makers this forces a them to focus on one of the two, while leaving the other to grow more severe. In most cases unemployment is tackled first, forcing money to inflate and firms to suffer a decrease in the value of their stock price as their real value is often inflexible. I would have to agree with many of the others who suggested changes in supply side policy to decrease minimum wage to tackle the issue of unemployment. However increasing salaries would likely be inconsequential if inflation is increasing at the same time, leaving fiscal and monetary policy to be implemented at later point to tackle the issue. So while some government intervention may be required, it is possible that the economy can self correct.

    #dtumanavarro

    While I agree with you that it is entirely possible for the U.S. Economy to self correct at some distant point in the future, I was wondering whether you had any insight into how this might happen. Do you believe that wages will drop on their own, or that government intervention is required to decrease union power and minimum wage?

  32. ahmadson 10 May 2013 at 10:25 pm

    1) Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    When the interest rates are lowered, the firms will be encouraged to take loans to invest in their business that will increase the aggregate supply.

    2) Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Because government don’t over view inflation as important when they are in sessions. They need support from the people and people will only support them if the government creates jobs for the people.

    3) “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    It is not automatically for this to balance itself in the short run however it is possible in the long run. This situation is called stagflation when the country is facing both higher rates of unemployment as well as higher rates of inflation. The government tacke this issue through fiscal policy, by promoting even and healthy growth and attempting to prevent inflation. If stagflation continues long enough, it will trigger an economic recession and an ultimate self-correction.

    Comment for #edubis: Hi Ellen, you have mentioned that governments need to intervene in order to tacke stagflation but I was wondering what were your exact suggestion?

  33. hteohon 12 May 2013 at 6:23 am

    My Response:

    Week 30 Blogosphere

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. However, lower interest rates can also result in positive supply-side effects of the economy. This is because it enables suppliers and producers to loan money from banks at a lower interest rate. Borrowing from a bank is more appealing to a firm since paying back the money would not be that much of a problem anymore due to the low interest rates; it is less expensive to borrow. Firms can then invest in capital goods for new labor skills, new technology etc. Other than that, the loaned money can also be used to expand the firm size and to hire more workers, which then contributes to lower unemployment. Once there is a larger workforce, there will be increased output, which would shift the aggregate supply curve to the right.

    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Increasing employment is of a higher priority to policy-makers than bringing down the inflation rate. People feel more important as an individual when employment is placed as a higher priority than inflation rates. When inflation is high, the value of the currency earn by people is lesser than what they used to earn. Maintaining a low rate of inflation is one of the macroeconomic goals. Unemployment is a higher priority because it affects a larger group of people. Inflation affects those who are earning an income whereas increasing employment can help those people of earning income. Yes, the fact that it is an election year matters. This is because policy-makers want reelection for their respective government, so by putting employment as a higher priority, it makes the individuals in the society feel more significant and more important. Most votes will go to the party that shows the ability to solve problems, and social problems are more important and more familiar in the individual’s eyes since it has direct connections with their lives.

    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    This situation is known as stagflation, where there is both high inflation and high unemployment increases simultaneously. The increase in wages is a good sign for the economy because it means that national income is increasing, which means the quality of life for the employed would increase as well. However, this is a situation where the number of unemployed also ends up increasing, which means that there will be lesser and lesser people to reap such benefits. Also, with rising wages, companies will lay off workers in order to decrease their production cost. Unemployment then rises and rising inflation will make the situation even more difficult. Then, aggregate demand will decrease, since there is lesser aggregate supply as firms have lesser workers. It is not likely for the US economy to “self-correct” from in times of an economic slowdown so the Keynesian economics would be more appropriate in this case. The government should intervene to correct stagflation, either through expansionary or contractionary policies.

    My comment on # masayaechlf09 ‘s post:
    I like how for the 3rd question, you provided the possible solutions that the government can approach to reduce inflation and unemployment. I agree that these solutions: reduce the power of trade unions who resist in reduction of real wage and impose minimum wage; issue combination of reduced benefit and lower tax to induce the unemployed to take lower paid job; increase geographical and occupational mobility through retraining; or establishing an efficient system of information flow for the unemployed would be able to combat the situation.

  34. Sasha_Son 12 May 2013 at 8:54 am

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Low interest rates, ideally, would lead to a situation where borrowing becomes more appealing to a firm because the paying back would not be so financially straining. Lowering them further would result in positive supply-side effects for the economy because it amplifies the effect that is garnered from having low interest rates in the first place. Lowering them makes loans and borrowing even more popular, and henceforth allows the borrowing firms to invest in more capital goods (machinery), and even help the firm expand. This may help the firm acquire a larger workforce, thereby eliminating unemployment as a problem, and with the increased output garnered from a larger workforce and improved/increased capital goods, the aggregate supply could shift to the right, signifying strength.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Unemployment is a matter of personal/individual importance as much as it is an economic matter. By having the employment being placed in a higher precedence than that of inflation rates, policy-makers are making it apparent that the people are more important than the state of the economy. What is somewhat curious about this relationship between inflation and unemployment is the fact that the two, to some extent, are interrelated. Inflation rates, if they are too high, reflect the fact that the value of the currency that is earned by people is less than they perhaps used to earn, effectively meaning that the people’s wages are cut, as they are, in essence, earning less than they used to earn. Maintaining a low rate of inflation is something that is very important to an economy, and, like unemployment (or rather, avoiding unemployment), it is a macroeconomic goal. Inflation, however, does not exactly result in unemployment, meaning that policy-makers can, in some ways, prioritize one over the other. Considering the second half of the question, election year is an incredibly weighted determinant in the appearance of such a prioritization. Policy-makers ideally want reelection for their respective government, and hence, by appealing to the people, not only as a collective, but also the ‘individuals’ that form the sum, they are making them feel much more important and significant. This gives them the feeling of having a voice, which is something very much appealing in a society. Thus, all things considered, unemployment is a higher priority because it more directly affects a larger group of people, as inflation merely affects the employed who are already earning an income, whereas fixing unemployment seeks to at least grant as many people as possible a form of income. With the incentive of reelection, prioritizing unemployment over inflation rates is quite a popular look for governments to have.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    Wages increasing is typically a good sign for the economy as it means that national income is increasing, and hence the quality of life for the employed is increasing. However, in a situation where the number of unemployed ends up increasing, there are less and less people who are able to reap such benefits. Wages increasing acts basically as a form of inflation, which means that both rising at the same time is the same thing as stagflation. In such an event, self-correction would effectively be an impossibility, which means that the government, against the apparent Capitalism that is evident in the United States, should intervene. This will make up for the inability to self-correct, and the government can act accordingly, manipulating factors so that there is restoration.

    To Daniel, I misinterpreted the third question, and now that I understand that wage increases are actually inflation, I understand how self-correction really is an impossibility with the United States if stagflation occurs. What measures/policies would you instigate for correction?

  35. Malen Kon 12 May 2013 at 5:03 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Lowering interest rates might result in positive supply-side effects for the economy because it will encourage investment and consumption. Lower interest rates means lower cost of borrowing. Firms will likely borrow from banks due to the lower interest rates and this will increase investments. With the new loan, firm can invest in capital to maintain the productivity of their existing capital or they can spend on capital to increase their output to respond to higher demand in the economy. This will lead to lower unemployment as firms hire more workers to meet the increasing demand. This will shift the aggregate supply curve to the right as labour is increased, leading to an increase in output.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Increasing employment is of a higher priority to policy-makers than bringing down the inflation rate because inflation will only matters to those who have a disposable income that can be spent however, unemployment will matter to everyone. Also, lower unemployment also means more spending as people have an income to spend. Inflation would then have less of an impact on those who spend their income than those who are unemployed without an income. Both inflation and unemployment are macroeconomic objectives of the governments however, unemployment would be more important because it will directly relates to the welfare of the citizens whereas inflation is more connected to the economy itself. The fact that it is an election year does matter because if the government does not use appropriate and helpful policies then the citizens would not be happy and that might result in less support for the government. The government must prioritize the people before anything else since the people has a say in the election.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    A combination of high inflation and high levels of unemployment is known as stagflation. The increase in wages means that national income is increasing, which is good for the economy as it means that quality of life of the employed are better. However, when the unemployed are also increasing, this means that less people are able to take advantage of this increase in wages. With rising wages, firms would not hire as much workers due to high costs. Unemployment then continues to rise along with high levels of inflation. If wages continue to rise even as unemployment rises, it is unlikely that the US economy will ever “self-correct” from in times of an economic slowdown. The government would need to intervene through expansionary or contractionary policies, demand or supply side policies.

    Comment:
    @Sasha_S
    Hey Sasha! I definitely agree with your response towards these questions however, in question 2, you mentioned, “Inflation, however, does not exactly result in unemployment”, I somehow find that quite confusing because inflation occurs when there is a sustained increase in the price level, with inflation, costs would become more expensive, therefore firms would not hire more workers than they need to as it will increase their costs, which in turn causes unemployment. Perhaps you can explain further what exactly you mean by that statement. Well done ?

  36. m2keoon 12 May 2013 at 6:49 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. However, lowering interest rates could also result in positive supply-side effects for the economy as suppliers and producers are able to get loans from the banks at low interest rates. Low interest rates also means low cost of borrowing, and thus attracting more firms to borrow as it is cheaper now. As already mentioned, this should lead to higher investment and consumption, which means higher quantity demanded and thus more output is needed. The money borrowed can be used to expand further and hire more labor, which reduces unemployment. Aggregate supply will be shifted to the right as unemployment rate decreases and more output is produced, and thus resulting in a positive supply-side effects for the economy.

    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    Increasing employment is of a higher priority to policy-makers than bringing down the inflation rate because even though both inflation and unemployment are variables of the macroeconomic objectives, but unemployment is considered of a higher importance than inflation and the reason lies on the fact that what matters more to the policy-makers are the people of the nation and not money. Having a low unemployment can reflects a lot about a country’s wellbeing as this would means higher standard of living and it also reflects the economic position of the country. Low inflation rate is a macroeconomic objective as well but it is not necessary the most important because again, inflation rate depends on the economic activities and its impact on the country is most likely to be lighter than unemployment problem. The fact that it is election year does matter because the citizens want a government who would prioritize them and care about their wellbeing so obviously the votes will go to the party that they have the most confidence in.

    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    It is very unlikely that the US economy will ever “self-correct” from in times of an economic slowdown because in this case, government intervention is very much needed. We can identify this situation as stagflation as both inflation and unemployment are rising. The fact that wages are rising is a good thing for the workers and for the economy as a whole because it would means an increase in national income, and thus a better standard of living and quality of life for the employed people. However, we also see that unemployment rate also seems to rise, which is a bad sign because it would mean that lesser people are enjoying the benefits of rising wages. When this happens, aggregate demand might fall because aggregate supply has also fallen since the firms need lesser labor and thus lesser output produced. Therefore the government would need to intervene in order to correct this stagflation either through demand or supply side policies and inflationary or deflationary policies.

    Comment:
    # Marcelo.echl.f09
    Hey there! Interesting response to question 3 as I did not really think of it that way but I think I got your point. The US could maybe ‘self-correct’ this situation because as you said when wage rises, labor costs become greater, and thus firms will most likely to fire workers to reduce their costs of production which further increases unemployment. It is not clear as of what really causes wage to rise but perhaps when we look at this in the long run, when more and more people are becoming unemployed, wage might fall as more people will be competing for jobs and thus accepting any amount of wage offered by firms. Or it could be as you said that those who enjoyed the rise in wage will spend more money and thus increasing aggregate demand, which makes firms wanting to produce more to further gain revenue and thus more labor will be needed.

  37. kkozlovskison 14 May 2013 at 9:53 pm

    As the consumtion will rise so will the money spent on the goods, so the companies recieving this money will be able to make more actions, because they will have money in their pockets, so they will benefit in this way.
    Bringing the unemployment down is more important than bringing the inflation down, because having worthless money in your pocket is better than having worthless people in your country. For the country it is more impotant to make people happy, not to make the money happy.
    The economy of US will self-correct, but it will self-correct to the nearest point where it feels good, but not to the point in the history which has been the best for it. So it will correct itself but to a point nearest to the current situation, not to that which seems to be the best.
    # m2keo
    I agree with your answer to the question no 2, because I also think that it’s important to bring down the unemployment rather than the inflation, because the people for a country is more important that it’s money.

  38. bdesslegnon 15 May 2013 at 9:29 pm

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Low interest rates are demand-side policies as they facilitate an increase in consumption and an increase in investment. This is due to the fact that saving will decrease as consumers are discouraged by low-interest rates and that investment will increase as investors are encouraged to borrow and invest because of low interest rates, therefore it is clearly a demand-side policy. Lower interest rates could be supply-side policies too. That is because, as more and more investments are emerging total supply of goods and services by an economy will increase as well.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    Policy makers should always be concerned about employment. People are most likely to blame policy makers for them not having a job. Even though inflation may be high, unemployment is the more pressing issue. If prices increase, I might still manage to buy some items, however if I don’t any source of income then I am more frustrated. Therefore, people fear losing jobs more than they fear increase in price-levels. Policy makers are aware of that and in order to stay in office they have to address the most pressing issue. With this in mind, it is possible that the fact that it’s an election year might matter. Proximity is very important when people make decisions, I will be more likely to vote for an official if I have a job now at the moment, I might not dwell on the past. And since politicians keen in on that issue, they will make sure most people are employed in an election year, to prolong their stay in office.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    Stagflation is the phenomenon that explains this economic slow-down. It is no-longer a trade off as both inflation and unemployment are rising. The inflation caused may be a cost-push inflation where by as labor cost increases short-run aggregate supply might decrease. In this process, however, employers are cutting jobs which is also resulting in higher unemployment rates. Government intervention is needed to reduce unemployment rates specifically, Keynes had helped the economic recovery of the capitalist world after the 1929 depression by introducing the need for government intervention. To wait for the economy to self-correct isn’t advisable, government intervention is crucial.

  39. bdesslegnon 15 May 2013 at 10:01 pm

    # m2keo
    Really thought out responses. Good job!

  40. ABarrowon 15 May 2013 at 10:36 pm

    1. Lowering interest rates may result in positive supply-side effects for the economy by making investment more attractive to investors (because of loans at lower interest rates), increasing the aggregate demand curve and the employment rate in the process.

    2. Because the solutions to unemployment are easier to tackle in the short-run, compared to the longer time it would take to substantially reduce the inflation rate, increasing employment is of a higher priority to policy-makers than bringing down the inflation rate.

    The fact that is an election year matters because of the demagogue nature of politicians running for office that need public support to triumph.

    3. This all depends of which unemployment economic model you follow, be it classical, neo-classical or Keynesian…but in all honesty, the US is a supermarket…so if wages continue to rise even as unemployment rises, and this proves bad…the US (who makes all the rules in international politics) will find a way to accommodate and change for the American market’s benefit…

  41. ABarrowon 15 May 2013 at 10:43 pm

    @bdesslegn

    Interesting take on what may happen to the US…Stagflation however, may be the least of America’s problems in the next couple of decades…because if the 3rd world has its way, America will loose the brunt of its international influence and supermarket power…

  42. david.yooon 16 May 2013 at 5:47 am

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investment and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?

    -The statement of lower rates will lead to positive supply side effect is correct because it will definitely increase consumer consumption. This is because if the bank lower the interest rate, the customers will more likely to borrow money from the bank as they don’t have to as much of interest rate as before. This eventually increases the consumer spending. Furthermore, the firm also borrows money from the bank as the interest rates decrease, which eventually increases the investment. Increase in investment will turn into increase in productivity, revenue, and also they will hire more employees to keep up the investment, which lowers the unemployment. Finally, these entire positive shifts will give positive sign to one country’s economy.

    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?

    -Increasing employment is a higher priority to policy makers than brining down the inflation rate. This is because increase in employment will not only increase savings and spent on consumers since they are getting income but also it will increase investment for the firm which eventually increase the economy of the country as a whole. However, low inflation rate is also a good sign but it means that there is less of an impact to people who is employed and spend their income. Lastly, election does matter to the country’s economy as well as the citizens’ satisfaction. This is because only choosing a right policy will give benefit to the economy and increase citizen loyalty to the government.

    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?

    – High unemployment and high inflation is what we called “Stagflation”. Although the employees’ wage is increasing, there are still people who are unemployed. Rising wage gives benefit to individual employee but it will make the firm to lower the employment as they have to pay employees more than before. At the same time it increases unemployment even more. To conclude, it is unlikely that the US economy will ever self correct as both inflation and unemployment are increasing. To correct this, I think the government should intervene.

    #Malen K
    Good response! I definitely agree with you that low interest rate will increase consumption, investment, and unemployment. Also, I liked how you said about government intervention at the last question as there are both high inflation and unemployment.

  43. avonwendorffon 21 May 2013 at 5:46 am

    1. Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
    Supply-side effects mean that they effect the output or quantity of goods produced. Lowering interest rates means that firms can loan money easier, and thus they can invest in better machinery and produce more. Also, consumers may chose to get loans when interest rates are low, and the demand and therefore the supply of goods will increase.
    2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
    I agree that unemployment is a bigger problem than inflation. People feel more personally connected when they are fired from their jobs than if the price of bread increases. If they lose their job, then consumers cannot buy anything (in theory). While inflation might be frustrating as you see your real income decreasing, you are still able to buy different foods.
    This being an election year is of course a factor. People without jobs will tend to vote against the party in power, as so called “retrospective voters.” They were unhappy during the past 4 years because they were out of work an unable to provide for their family, so they will vote out the current party. To combat this, the current party will work to decrease unemployment prior to an election.
    3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising inflation worries. Wary employers have cut jobs every month so far this year and aren’t inclined to be overly generous in their compensation to workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
    If wages rise as unemployment rises, it is unlikely that the US economy will ever “self correct.” The system consolidates the rich and the poor. There is a smaller group of people that earn the wages they need to survive comfortably. The government will need to step in, as they have done, to regulate the money supply or interest rates, for example, so that this gap decreases.

  44. avonwendorffon 21 May 2013 at 5:52 am

    Hi # Mkhoso,

    You had very well thought out answers! I do, however, think that unemployment is more than a “short term boost” prior to an election. People are undoubtedly more responsive to employment data than inflation data, and this is used as a political tactic during elections, but I think the implications and effects last long after an election. Low unemployment is one of the macroeconomic goals of a nation.

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