National Economic Policy

Readers Question: When considering national economic policy government must accept that there is a trade-off between inflation and unemployment. Discuss.

See previous essays. But ideas for an essay plan include:

Depends on situation of economy. E.g. current policies to boost Aggregate demand are not being inflationary because there is so much spare capacity in the economy. In the current situation attempts to reduce demand deficient unemployment are not causing inflation – at least in the short run.

However, in the future, the current policy of quantitative easing (increasing money supply) could well reduce demand deficient unemployment but cause inflation.

Depends How Much You increase Aggregate Demand. If the economy is in a recession and the government use demand side policies to boost growth. Inflation is likely to occur if growth exceeds the long run trend rate. If aggregate demand increases faster than aggregate supply.

However, if aggregate demand increases at same rate as AS (in UK this tends to be 2.5% a year) then inflation shouldn’t be a problem.

Natural Rate of Unemployment It depends how the government seek to reduce unemployment. If you can reduce the natural rate of unemployment (frictional and structural unemployment) then these policies will not be inflationary. Inflation is a threat when using demand side policies.

From 1994-2007, the government reduced unemployment without causing inflation.

See Previous Essays

Trade off between unemployment and inflation

Phillips Curve – Inflation and Unemployment

Economic Trade offs