Fight Unemployment or Inflation First?

Public sector employment and transfer payments are limited by the amount of revenue which can be raised, which in turn is limited by how much the private sector can provide without ceasing to be viable, or how much can be borrowed without creating a “deficit bomb”.

To achieve full employment it is necessary to give this goal priority over all others. However the “price to be paid for full employment” must not have an effect contrary to its purpose, so that society ends up paying a price without receiving the goods.

Depending on their colour, politicians in the 1970’s and 1980’s made a false choice between fighting unemployment first, or giving priority to lowering inflation. It was believed that full employment could only be achieved at the cost of higher inflation and deficits and that holding inflation down had to be at the cost of high unemployment.

This fallacy arose from incomplete understanding of Keynes’ theory and, as mentioned earlier, a mistaken belief that his remedies for the economic problems of his time were appropriate for any economic ailment that displayed unemployment as a symptom.

Under those conditions of “stagflation” which threaten to recur in our time, the increased inflation was a sign that the remedies of the 1930’s were not appropriate today. The deficit financing involved and the inflation this helps to cause exerted downward pressure on throughput; the latter because it caused uncertainty and reduced the marginal efficiency of capital, and both because they increased interest rates. The effect was upward pressure on unemployment.

Of course, policies pursued at that time either to reduce unemployment or control inflation, tended to succeed, if at all, with one at the expense of the other. But this was not because full employment and low inflation were incompatible; it was because the policies worsened the underlying problem of ratio distortion, aggravating its effects and producing a rise in inflation out of proportion to the fall in unemployment, or vice versa, depending on which one was being attacked first.

A sustained attack on inflation brought it down somewhat at the cost of a larger proportionate rise in unemployment.

The latter would cause a change in government policy or in government itself, and an attack on unemployment would begin, which might reduce it somewhat at the cost of a disproportionate rise in inflation.

This is why every swing of “boom” and “recession” in those years, over the full cycle, left the combined problem of unemployment and inflation at a higher level than before.

The reality was that inflation, high public debt, and unemployment in the more perfluent nations at that time were symptoms of the one problem, rather than separate problems between which a choice had to be made. As an analogy, a doctor treating a patient should not make a choice to treat one symptom to the neglect or worsening of another. Rather the underlying disease, which gives rise to both symptoms, should be attacked.

The problem has been stated, and will be summarised again; external constraints slow down the rate of throughput increase; excessive expectations push up money wages; this pushes up unemployment, inflation, and deficits; all four upward pressures depress throughput and remedies for them can worsen them and depress throughput further, pushing up unemployment and still creating upward pressure on wages.

The seed of the problem: indefinitely increasing throughput depleting limited resources, and wage demands based on what people think they ought to be able to buy rather than on what the economy can make available at any time.

Earlier it was said that rising or maintained material living standards cannot forever go together with full employment. In the light of what has been said in this posting, a general statement can be made.

Full employment (a) and moderate inflation (b) and moderate interest rates (c) can always exist together; b and c and the maintenance of living standards for those employed (d) can always exist together.

But a, b, c and d cannot always exist together. They can do so for short periods, but this happy state is not sustainable.

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