Inflation_vs_Unemployment

Inflation is the constant increase of the average price levels. This is due to a demand pull. Too much total demand in the economy without an increase in aggregate supply is caused by increases in consumer, firms and government spending. This is also due to a cost push. Increasing costs is due to the increase in wages and salaries, improving profit margins and the increase of indirect tax rates by the government. Inflation is also defined as the decrease in purchasing power of a national currency. Four indicators of this are excessive printing of currency, increased costs, increased national debt and increased taxes. The mass flowing in of money is actually hidden tax, so every new bill included in the circulation reduces the purchasing power. More currency is printed due to the debts that have to be paid thus becoming a cycle. Another domino effect is the increase in cost of raw materials leading to increase in labour and production costs which lead to the increase in prices of goods. Inflation is popularly known to be unhealthy for a country’s economy. However, it has its advantages. First, a controlled growth of inflation may become a part of business growth. This growth in the economy would lead to lower unemployment rates. For instance, an increase in aggregate demand will result in an increase of price level and in real output. Suppliers will try to match the demand by producing more. This means that more labour is needed thus in the short term more people will be employed. Second, higher inflation “eats” away the real value of a currency. This means that the actual value of debts decrease, benefitting business and private individuals in debt. Third, it increases the value of stocks bought at an earlier value making the stocks have a higher selling price thus higher profitability. Fourth, the values of fixed assets could increase making companies more financially secure. It also causes people to have a “money illusion” or they feel richer. There are two types of inflation. The costs of unanticipated inflation are greater than anticipated inflation. Unanticipated inflation redistributes income and wealth. If the inflation is higher than expected, debtors are in favour because the value they repay creditors is worth less in terms of purchasing power. Similarly, it benefits the government because it is a large debtor and gains tax revenue as nominal income increases. If inflation is greater than nominal interest rate then people would rather have their savings spent instead of having a net loss by placing them in banks. If there’s lesser savings, banks have lesser money to lend for investment. This means that GDP will decrease since investment is a component of it. This is a short term effect because the rate can be adjusted accordingly by the central bank. Unanticipated inflation can cause net exports to fall because it makes goods produced in other countries cheaper thus increasing imports. Because unanticipated inflation means that the inflation rate is very variable, resources will not be allocated well. More resources may be devoted to predicting inflation and the rest will go to the production of goods and services. Also, firms may concentrate more on short term projects than long term projects. Anticipated inflation affects economic growth negatively in the long run through the cost of changing prices and holding cash. One of the costs of anticipated inflation is called the menu costs. Firms have to calculate their new selling prices and update the displayed prices. Because of the costs of changing prices, most especially for fixed capital, firms delay doing this creating a variability of prices among firms. This takes a lot of time and resources for individuals and firms to research before making decisions which then reduces the level of productive economic activity. Inflation reduces also reduces the real value of fixed incomes and savings. When wage and price increase, people are moved into higher tax brackets. Also, since the tax charged on the interest earned in bank accounts is based on its nominal value, both the interest and the deposit itself are taxed. Other costs of inflation include shoe-leather costs, psychological and political costs. The people who are more badly affected by inflation are the poor, those on fixed incomes and those paid in cash. The possible ways to tackle inflation are setting higher interest rates and slowing money supply by central bank, reducing demand and government spending by taxation through deflationary fiscal policy and deflationary monetary policy. The problem with this however is that the central bank and the government might not see eye to eye because the government is concerned with their reputation while the central bank has its own objectives. To overcome the cost of holding cash, people tend to have less of it in hand and put their savings in interest-bearing accounts. They withdraw only when they need it. This however may bring about missed opportunities and time wasted for not having immediate cash. The cost of reducing inflation involves higher interest rates to reduce spending and investment. The reduction in aggregate demand may lead to a decline in economic growth and unemployment. Unemployment is the number of people out of work. The rate of unemployment is the measure of this at a point in time. It increases when the number of workers having jobs is lesser than those who are losing their jobs and if the people seeking jobs are more than the number of jobs available in an economy. There are four types of unemployment. Frictional unemployment is the going in and out of jobs of workers. It is short term and is not really a problem if there are high unemployment benefits and more job information because workers can have a shorter time to look for jobs while still being able to sustain oneself while looking for a job. Seasonal unemployment depends on the needed skills in a specific season thus the demand for labour varies throughout the year. Structural unemployment happens when supply of labour is greater than the demand for it. For instance, workers are replaced by new technology or are laid off because the firm is not doing well or are in a geographically immobile place. This will increase unemployment if the workers don’t quickly receive training for other and relocate fast, they may remain unemployed for a period of time. Cyclical unemployment occurs when there is not enough aggregate demand for the factors of production to be fully utilised. The costs of unemployment are greater in the long run than in the short term. The unemployed and those who are dependent on him/her lose out because of the loss of income the person could have earned when employed. The cost is not only financially but also socially and mentally. Being unemployed suggest that the person is a failure which causes depression then leads to suicide. Also, the longer the unemployed takes in being employed again, that person will have a lesser chance in getting a job. This is because being out of work reduces their skills and their opportunity in being trained with the latest developments. Also, employers will use the unemployed time length as a basis to judge whether the person is skilled or not. The longer the time period the more rational it would be for the employer to not consider the applicant because he/she could be a disruptive employee or has been turned down a lot by other employers. Therefore, the unemployed is stuck in this related situation. Unemployment also brings about costs to the community. These are increased crime rate, areas with high unemployment become run down, streets become filled with street dwellers, shops go out of business and households are not able to maintain their places. The unemployed also affect the taxpayers. Government gives out benefits while losing revenue because of the taxes that would have been paid if the unemployed have jobs. Therefore the taxpayers would have to pay more to cover the increase in government spending and to make up for the taxes that the unemployed were supposed to pay. A greater loss is the loss for the whole economy. Output level decreases therefore wasting resources because they are not maximised. This then lowers aggregate supply. In the short term, desperate employees will begin to accept any job at low wages and those employed will accept wage cuts to keep their jobs. The fall in real wages causes a rise in aggregate supply and a recessionary gap. The decrease in aggregate supply causes inflationary gap. Based on all the information about inflation and unemployment plus additional research, I have come to a conclusion. In the short term, there is an inverse correlation between inflation and unemployment known as the Phillips curve. Therefore, the issue is tackled side by side. However, in the long run there seems to be no correlation between the two. Therefore, it can be tackled individually thus allowing economists to focus on the long term effects of the two than just the short term effects. For instance, according to David Blanchflower, in the short term inflation may seem helpful in paying off public and private debts. It also helps control interest rates just in case economic activity decreases. However, in the long term inflation will create a domino effect of problems. Other reasons include one, unemployment can’t be zero. There will always be dissatisfied workers and this is the natural unemployment rate. Although there is a burden to look after the unemployed, it is only short term. The benefits of having unemployment is that an employer may have a handful of applicants to choose from and it helps decrease the amount of wages an employer has to pay their employees. Also, even if a high unemployment rate slows the whole economy down, there is room for improvement. It is better to have the different types of unemployment which will solve its own problems rather than have a fast moving inflation that requires many policies to be implemented. Even if the policies are implemented, it affects the different parts of the economy which will again need different policies to solve it. For instance, inflation may lead to lower living standards in the long run. It will affect not only the unemployed but also the employed. Unlike in the case of unemployment, only the unemployed people have a temporary lower living condition until they find a job. High unemployment doesn’t create confusion about the future economy. High inflation does which tend to reduce business investment thus slowing down of growth. However, looking at the social costs, unemployment can last for a long time. For instance, even if inflation was successfully reduced, it could be at the cost of a deep recession. This would lead to a great unemployment rate. There could be possible riots which would affect the whole community. This means that the consequences of inflation don’t necessarily mean that it is more harmful to the economy than the consequences of unemployment. It is very subjective. It depends on the current situation and may change according to future events that will happen. Citation: http://ezinearticles.com/'The-Four-Economic-Benefits-of-Inflation&id=2102601 http://ezinearticles.com/'4-Indicators-of-Inflation-and-What-They-Mean-For-Your-Financial-Well-Being&id=4881738 http://www.bized.co.uk/virtual/economy/policy/outcomes/inflation/inflth4.htm