Prices of essentials such as bread are high and rising too fast, Americans say, even while unemployed people are thronging job fairs looking for work. Prolonged unemployment has major economic, social and psychological costs, while high inflation undermines the role of money. -- PHOTOS: REUTERS, AGENCE FRANCE-PRESSE
Which should governments be more concerned about: inflation or unemployment?Both are detrimental at high levels. Prolonged unemployment has major economic, social and psychological costs. Failure to find a job results in foregone production and can atrophy skills. The inability to earn an income breeds resentment and despair. Voters punish incumbents at election time.
In turn, high inflation undermines the role of money. Delays in adjustment of wages to meet higher consumer prices erode workers' real income. Unforeseen inflation arbitrarily robs savers, including the poor, by eroding the value of their savings; and rewards debtors, including the state. High inflation distorts decisions about saving, investment and production and ultimately leads to slower economic growth.
Governments can achieve both low inflation and low unemployment - but only over the medium term, and provided they implement effective institutional policies. All central banks nowadays, even if they operate differently, aim to achieve a low and stable long-term rate of inflation - typically about 2 per cent. Gone is the belief that high inflation can raise prosperity and employment on a sustained basis. A medium-term timeframe also permits eliminating cyclical unemployment. But the end of a recession still leaves many chronically jobless in many countries.
Minimising such structural unemployment requires well-functioning labour markets, dedicated human resource policies, and a development strategy that makes it profitable to invest and hire more workers. Minimum-wage laws deprive some workers of job opportunities while high taxes on labour and restrictions on layoffs discourage hiring. Improved matching of labour supply and demand across regions and industries reduces unfilled vacancies and unemployment. Job retraining and access for all to quality education can equip workers with the skills demanded in a rapidly evolving marketplace.
In the longer-term perspective, low inflation and sustained high levels of gainful employment are equally valid goals. By contrast, in the short term, one priority tends to dominate, especially at the extremes of the business cycle.
In the depth of recession, for example, when inflation is subdued, the obvious concern is unemployment. Keynesian macroeconomics calls for countercyclical fiscal and monetary policies to reduce either unemployment or inflation and shorten the economy's self-correcting process.
Critics have noted the limitations of such fine-tuning: First, implementation delays of fiscal stimulus and long lags in monetary policy can in fact exacerbate the economy's boom and bust cycles. Second, asymmetrical application in many countries has led to potentially unsustainable indebtedness, which in turn can blunt macroeconomic stimulus. Public debt has risen as governments failed to build surpluses during boom years; private debt has risen as governments are perceived to be backstopping risky lending practices.
At other times, adverse supply shocks can present a dilemma. Steep commodity price increases in the 1970s, for instance, resulted in high unemployment coexisting with inflation. Such stagflation requires deft navigation between two undesirables. Governments must prevent the one-time price increases from igniting a price-wage spiral but they should also not aggravate a rising unemployment problem. Only a decline in real wage costs, albeit temporary, can arrest job loss. But popular pressure often mounts for price controls or consumer subsidies that ease the short-term pain but at long-term cost.
Trying times remind us that prevention trumps cure. A consensus in favour of policies that combine worker security and solidarity with efficient outcomes will prove invaluable.
The writer is a visiting professor at the Lee Kuan Yew School of Public Policy, NUS.
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