Inflation and unemployment

September 20th, 2010  |  Published in Politics

An interesting paragraph from James Surowiecki in the New Yorker, who observes that an increase in inflation would be good for employment growth:

Unfortunately, when the Fed meets this week, it’s unlikely to be talking up the merits of an inflation boost. Central bankers are congenitally obsessed with the dangers of inflation and are more concerned with stable prices than with lost jobs. Also, the Fed, by its nature, looks after the interests of lenders, for whom inflation is generally bad news. But there’s a more basic reason, too: people really, really hate inflation. In polls, voters regularly cite high prices as one of their biggest concerns, even when inflation is low. A 2001 study that looked at the “macroeconomics of happiness” found that higher inflation put a severe dent in how happy people reported themselves to be. The distaste for inflation is such that a 1996 study (titled, aptly, “Why Do People Dislike Inflation?”), by the Yale economist Robert Shiller, found that, in countries around the world, sizable majorities said that they would prefer low inflation and high unemployment to high inflation and low unemployment, even if that meant that millions of extra people would go without work.

If we stipulate that there is in fact a trade-off between inflation and unemployment, and that people really hate inflation, then a policy of minimizing inflation would appear to result in diffuse benefits and concentrated costs. That is, most people benefit (at least psychologically) from lower inflation, but at the cost of imposing severe hardship on the unemployed who would otherwise have jobs.

All things being equal, one would expect this to be an unlikely and unstable policy outcome. It's generally hard to impose a policy with concentrated costs and diffuse benefits, since the losers will tend to care about opposing the policy more than the winners will care about defending it. In this case, the losers (the unemployed) should mobilize to demand employment-generating policies, even at the cost of increasing inflation.

In this case, such a dynamic is probably blocked by the fact that the unemployed are a weak and disorganized interest group. Politicians are also able to avoid blame for unemployment by what Paul Pierson called the strategy of obfuscation, in which politicians act (or fail to act) in ways that conceal the relationship between their actions and policy outcomes. In this case, there are two stages of obfuscation. First, most people probably aren't very aware of the degree to which the Obama administration has refused to change Federal Reserve policy on inflation, chiefly through their desultory approach to getting Federal Reserve Board nominees confirmed. Second, people also don't really understand the relationship between inflation targeting and unemployment. As a result, there's no demand for a policy that promotes both inflation and employment.

In this context it's all the more important that the people most affected by bad policy get organized. Hence the importance of things like the Unemployed Workers Action Group.

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