Understanding the Role of Unemployment in Taming Inflation

In the context of monetary policy, unemployment plays a crucial role in managing inflation. This article explores the relationship between unemployment and inflation, particularly focusing on the actions of central banks like the Federal Reserve (Fed) and the broader implications for maintaining economic stability.

The Fed's Role in Unemployment and Inflation

The Federal Reserve, in pursuit of the Humphrey-Hawkins mandate to balance inflation and employment, relies on a concept known as the 'natural rate of unemployment.' This natural rate is a theoretical measure that suggests a level of unemployment at which the economy is stable, and inflation remains benign. However, it's important to understand that 'natural rate' doesn’t refer to a specific number but rather a range within which the economy operates without significant inflationary pressures.

The Fed assumes that even a subset of the workforce that is 'between jobs' contributes to this natural rate. When unemployment falls below this rate, competition among firms for workers intensifies. This wage competition leads to cost-push inflation, where higher labor costs are passed on to consumers, causing a general increase in the price level. It's important to note that this 'general price level' does not mean all prices increase uniformly; rather, it refers to an overall average increase.

Historically, in 2018 during the Trump presidency, the unemployment rate dropped to levels that were deemed too low by many economists. This resulted in anecdotal evidence of increased wage competition among firms. However, the reaction from the liberal media was tepid at best, with some viewing the situation as the best possible outcome for a Republican administration. According to the theory of 'cost push' inflation, this wage competition was a clear indicator of potential inflationary pressures.

Theories of Inflation: Government Actions and Money Supply

The article presents a different perspective on the cause of inflation. Unlike the 'cost push' theory, it posits that inflation is the result of government actions that inflate the money supply. This means creating new money out of thin air, which fundamentally distorts the value of currency over time. In essence, the creation of money without equivalent economic growth causes inflation.

To illustrate this, the article draws a parallel to the concept of weight gain. Just as weight gain results from consuming more calories than one burns, inflation results from an oversupply of money. The solution to weight gain is not to try to 'tame' it but to address the underlying issues by reducing calorie intake or increasing physical activity. Similarly, the solution to inflation is not to 'tame' it but to stop the creation of new money.

This perspective has historical precedent and is supported by economic theories dating back centuries. Governments inflating the money supply for short-term gains can lead to long-term economic instability. It's crucial for policymakers to understand that inflating the money supply can have serious and adverse consequences far beyond the immediate economic benefits.

The Future of Inflation Management

Given the above understanding, the article questions the effectiveness of current economic theories in managing inflation. It argues that there is a need for more rigorous and transparent economic policies to avoid the pitfalls of uncontrolled money supply growth. Central banks should be more proactive in monitoring the money supply growth and ensuring it aligns with economic growth rates.

In conclusion, while the Fed and other central banks play a crucial role in managing inflation, the broader issue lies with government actions that artificially inflate the money supply. Addressing this systemic issue requires a shift in economic thinking and more transparent monetary policies. The goal should be to stop inflation rather than to try to tame it, as taming it only temporarily masks the underlying economic issues that lead to inflation in the first place.

Keywords: unemployment, inflation, monetary policy, cost push inflation, money supply