Unemployment and Inflation: Can We Find a Balance - Coursework Example

Economic Policy Recommendation – Unemployment and Inflation: Can We Find a Balance?  Unemployment and Inflation: Can We Find a Balance?  Unemployment is the percentage of total workforce in an economy who is not able to find a job despite being willing and able to work (Hall and Lieberman, 2009). The level of unemployment at a given time differs with circumstances like economic conditions. Inflation on the other hand is the rate at which the average prices of goods and services rise and the purchasing power falls. The aim of an economy is to maintain the inflation level at 2-3% annually ‎(Moreno, 2012). ‎ Major Impact on Society Unemployment and inflation are interrelated economic concepts. Unemployment has several impacts on the society, the major one being the numbers of people that are unemployed now become dependent on the government both financially and in health regards. The government is then supposed to assist these people in fulfilling their needs of basic things like shelter, food, medical assistance and financial assistance. For these purposes government initiates programs like housing authority, SNAP and for medical care; Medicare. These programs of government assistance to the unemployed are funded by tax payer’s money. The unemployment costs however are not just financial, they are widespread. It can have psychological effect on those where the prestige of a person was associated with their job; in majority of the cases. It has also been found that the rate of crime, suicide and the divorce rate heighten when unemployment increases. (O’Sullivan et al, 2008) One of the other major impacts on the society of unemployment is the money that is spent by government in form of the unemployment benefits; it also signifies a loss in the tax earnings which then mean that there is less spending in an economy and the companies are getting lesser revenue, thus slow down in the economic activity as whole.  Inevitably when there is discussing about government expenditure on these stimulus programs and benefits to lower the unemployment levels, there evolves the problem of inflation. This is usually caused as the increased expenditure and lower revenues increase the national debt, which can cause inflation in the economy. Inflation has several impacts on an economy itself, among those the basic one is that it decreases the purchasing power of the dollar and causes it to depreciate ( Folsom and Boulware, 2009) . The depreciation of dollar although may reduce the living standards in general due to falling power of purchasing it is harder on those with fixed incomes, like the retired as their income will now buy less without any compensation for inflation. The people who are not dependent on fixed incomes however may have better ability to come as their incomes may be adjusted for inflation. Another effect of inflation that can be destabilizing is that it will cause change in the spending habits of both investors and the consumers. In long period of inflation people will start spending less which would mean a fall in demand thus less revenue and work for the factories that would then fire some workers to adjust to the fall in demand and revenue. The inflation also results in heavy speculation by some people who try to take benefit from the higher levels of prices. Due to some of the investments being high risk purchases the spending is then diverted from the usual channels, this may result in unemployment or if the inflation is a result of unemployment, in that case further unemployment. Inflation also effects distribution of the income, creditors are usually more effected that the debtors as the loan they had given is returned in the form of inflated dollars, which hold lesser value than they did at the time of lending ‎(Moreno, 2012). ‎ Proposed Economic Policy Solution to the Problem The relationship between unemployment and inflation has been studied by various economists over the years. They have tried to deduce the relationship that exists between the inflation and unemployment concepts. It has come down to the two possible relationship explanations between them. The first one is that which exists in short term and the other being that in long term. In short term the relationship between unemployment and inflation is inverse, as one of them increases the other decreases; if the level of unemployment increases, then inflation decreases and vice versa. (William and Melvin, 2011) This relationship is problematic for the policy makers, as it poses several different problems. This relationship between the unemployment levels and inflation is illustrated by the Phillips curve. In short term the curve is shown to be declining. In the long term however the curve is illustrated differently, due to the fact that in the long run economists believe that the issues of unemployment and inflation don’t have any relation. The classical inflation view suggests that the inflation is a result of changes in the money supply. When the supply of money increases in the economy, the price levels of goods and services rise too. This is the basic sign of inflation. The economists that hold the classical views believe that there exists a natural rate of unemployment; also known as equilibrium of the unemployment level in a certain economy. It is also known as Phillips curve in the long term. It is shaped vertical referring to the fact that inflation has no relationship what so ever in long term with unemployment. This is why it is assumed that the unemployment will remain fixed at a point despite the level of inflation. In general terms if unemployment rate is less that the natural rate, then inflation rate would exceed the expectations limit and be higher than expected. On the other hand if unemployment is more than the equilibrium limit, it would result in inflation being lower than what was expected. The Keynesians economists however have a different school of thought than the classics. According to Keynesians school of thought, inflation is regarded as a result of constant increases in the money supply. They are concerned mainly with institutional crisis which are faced by the people as a result of increasing level of prices. They argue that the company owners keep increasing wages and salaries of the workers to conciliate them. This is done by increasing profits by raising the prices of goods and services manufactured or provided by them. To do so there has to be increased money supply in order for economy to keep functioning. This makes the government spending increase as it injects money in the economy to meet demand and stay with the inflation rates. If looked at separately then an economic policy that can solve the issue of unemployment can be flat tax. Flat tax is a system of income tax where everyone has to pay the same rate of tax despite their income levels (Moreno, 2012). The proposal to use flat tax was also made by the Governor of Republican party in Texas; Governor Perry. He proposed this to be the solution of economic policy problem. There is another proposal to solve the issue of unemployment, which is to stop or halt the sending of jobs overseas as well as exporting more than importing. Currently the United States has fewer exports in comparison with its imports. The lowest compensation cost at hourly rates being in Mexico, which is attraction for the U.S companies to import from due to the lower costs. Inflation on the other hand can be solved by altering the monetary policy of the country; increasing the interest rates. The alterations in monetary policy have been used as the most important tool to reduce the inflation in both U.K and the U.S. although the monetary policy has to consider both national and international scenario as the business world is increasingly becoming interlinked due to globalisation. Economic Theory Predicts the Policy Would Work This policy to reduce the unemployment can work because unemployment usually evolves when the wages are too high, even above the competitive levels. To solve unemployment the demand needs to be expanded or if the operation is that of competitive forces then rely on the market forces to automatically force the wage rates down to where the demand of labour is equal to amount supplied (Sharp et al, 2010). The theory policy is referred back to the exports and the imports where the jobs can be kept locally if the importing is reduced and exporting increased in the U.S. This can be done by increasing local cultivation of agriculture like fruits and vegetables, livestock etc and manufacturing or larger scale to fulfil the demands of local population rather than doing it by importing the products which are not produced enough locally. Another way this policy could work is by growing the business sector locally for example making call centres in the U.S, computer companies, communications and insurance companies which are send to the cheaper third world countries. Inflation is usually as a result of increased spending or money injections in the economy. The economic theory backs up the policy of altering the monetary policy by increasing the interest rates in order to lower the levels of inflation. This is because when the interest levels are higher it also raises the borrowing costs; this discourages people from taking loans and thus spending excessive money. Apart from controlling the borrowing of money which does not seem too desirable with higher interest rates, it also makes saving look more attractive to people thus they start emphasising more on saving then spending. Increased interest rates not only alter the borrowing and saving rates but they also tend to lower the disposable income held by those who have mortgages. This rise results in increasing the exchange rate value too, this then ultimately leads to increasing the number of imports and reducing the exports, as now money can buy more of the foreign goods which come cheaper. Yet this clashes with the interests of lowering the unemployment, implying short term Phillips curve. Proposed Economic Policy Impact on the Market Role in Solving the Economic Problem This proposed economic policy of flat tax would have impact on the market and solve the problem of unemployment where everyone is paying the same rate of tax. When everyone will be contributing, money will go back in the economy; this will create expenditure, growth of businesses, business opportunities and development. When economy starts to re-grow and develop it then creates more job opportunities as more business sprout and already existing expand, it in turn makes investors and consumers feel more secure than more, thus the expenditure increases. By controlling imports and exports U.S would be able to create jobs as well as keep the business growth within its economy. This proposed economic policy would alter the exchanges in market by reducing the flow of money which will automatically reduce demand. When people start saving more and borrowing thus spending less the demand is forced downwards. When the demand is lowered the production of the goods and services will slow down automatically as the inflationary pressure is reduced on the production, thus pushing the prices of goods downwards. In other words this would result in deflation. While imposing high interest rates and putting a downwards pressure on inflation the policy makers should be careful not to push it too hard that the unemployment increases considerably and inflation goes below the required levels of 2-3% for healthy economic growth ‎(Moreno, 2012). ‎ In order to find balance between the unemployment and inflation levels due to their inverse relationship, economists or the policy makers should focus on finding the balance between unemployment and inflation levels; the point where there is natural rate of unemployment and tolerable level of inflation. That would be the best possible trade off between the two, since both cannot be reduced at the same time, at least not in the short run, finding equilibrium is the most effective way to solve these together. References Folsom, D. and Boulware, R. (2009). Encyclopedia of American Business, NY: Infobase Publishing. OSullivan, A., Sheffrin, S. M., and Perez, S. J. (2008). Principles of Economics (3rd ed.).Upper Saddle River, NJ: Prentice-Hall, Inc. Moreno, T. (2012). What Is a Flat Tax System? Retrieved online from http://taxes.about.com/od/statetaxes/a/Flat-tax.htm Robert E. Hall, Marc Lieberman (2009). Macroeconomics: Principles and Applications. London: Cengage Learning. Sharp, A., Register, C., & Grimes, P. (2010). ECO 405: Economics of social issues: 2010 custom edition (19th ed.). Boston, MA: McGraw-Hill. William B., Melvin, M. (2011). Fundamentals of Economics. London: Cengage Learning. Read More