{"id":2269,"date":"2015-06-19T21:17:21","date_gmt":"2015-06-19T21:17:21","guid":{"rendered":"https:\/\/courses.candelalearning.com\/masterymacro1xngcxmaster\/?post_type=chapter&p=2269"},"modified":"2016-07-28T21:13:49","modified_gmt":"2016-07-28T21:13:49","slug":"policy-implications-inflation-recession-and-unemployment","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-hccc-macroeconomics\/chapter\/policy-implications-inflation-recession-and-unemployment\/","title":{"raw":"Reading: Policy Implications: Inflation, Recession, and Unemployment","rendered":"Reading: Policy Implications: Inflation, Recession, and Unemployment"},"content":{"raw":"
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Fighting Unemployment or Inflation?<\/span><\/h2>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\nAs explained in the unemployment section, unemployment can be divided into two categories: cyclical unemployment<\/em><\/a> and the natural rate of unemployment<\/em><\/a>, which is the sum of frictional and structural unemployment. Cyclical unemployment results from fluctuations in the business cycle and is created when the economy is producing below potential GDP\u2014giving potential employers less incentive to hire. When the economy is producing at potential GDP, cyclical unemployment will be zero. Because of the dynamics of the labor market, in which people are always entering or exiting the labor force, the unemployment rate never falls to 0%, not even when the economy is producing at or even slightly above potential GDP. Probably the best we can hope for is for the number of job vacancies to equal the number of job seekers. We know that it takes time for job seekers and employers to find each other, and this time is the cause of frictional unemployment. Most economists do not consider frictional unemployment to be a \u201cbad\u201d thing. After all, there will always be workers who are unemployed while looking for a job that is a better match for their skills. There will always be employers that have an open position, while looking for a worker that is a better match for the job. Ideally, these matches happen quickly, but even when the economy is very strong there will be some natural unemployment and this is what is measured by the natural rate of unemployment.\r\n\r\nThe neoclassical view of unemployment tends to focus attention away from the problem of cyclical unemployment\u2014that is, unemployment caused by recession\u2014while putting more attention on the issue of the rates of unemployment that prevail even when the economy is operating at potential GDP. To put it another way, the neoclassical view of unemployment tends to focus on how public policy can be adjusted to reduce the natural rate of unemployment. Such policy changes might involve redesigning unemployment and welfare programs so that they support those in need, but also offer greater encouragement for job-hunting. It might involve redesigning business rules with an eye to whether they are unintentionally discouraging businesses from taking on new employees. It might involve building institutions to improve the flow of information about jobs and the mobility of workers, to help bring workers and employers together more quickly. For those workers who find that their skills are permanently no longer in demand (for example, the structurally unemployed), policy can be designed to provide opportunities for retraining so that these workers can reenter the labor force and seek employment.\r\n\r\nNeoclassical economists will not tend to see aggregate demand as a useful tool for reducing unemployment; after all, if economic output is determined by a vertical aggregate supply curve<\/em><\/a>, then aggregate demand has no long-run effect on unemployment. Instead, neoclassical economists believe that aggregate demand should be allowed to expand only to match the gradual shifts of aggregate supply to the right\u2014keeping the price level much the same and inflationary pressures low.\r\n\r\nIf aggregate demand<\/em><\/a> rises rapidly in the neoclassical model, in the long run it leads only to inflationary pressures. Figure\u00a012.8 shows a vertical long-run AS curve and three different levels of aggregate demand, rising from AD0<\/sub> to AD1<\/sub> to AD2<\/sub>. As the macroeconomic equilibrium rises from E0<\/sub> to E1<\/sub> to E2<\/sub>, the price level rises, but real GDP does not budge; nor does the rate of unemployment, which adjusts to its natural rate. Conversely, reducing inflation has no long-term costs, either. Think about Figure\u00a012.8 in reverse, as the aggregate demand curve shifts from AD2<\/sub> to AD1<\/sub> to AD0<\/sub>, and the equilibrium moves from E2<\/sub> to E1<\/sub> to E0<\/sub>. During this process, the price level falls, but, in the long run, neither real GDP nor the natural rate of unemployment is changed.\r\n
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\r\n\r\n[caption id=\"attachment_4612\" align=\"aligncenter\" width=\"390\"]\"The Figure 12.8.<\/strong> How Aggregate Demand Determines the Price Level in the Long Run As aggregate demand shifts to the right, from AD0 to AD1 to AD2, real GDP in this economy and the level of unemployment do not change. However, there is inflationary pressure for a higher price level as the equilibrium changes from E0 to E1 to E2.[\/caption]\r\n\r\n \r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n
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LINK IT UP<\/h3>\r\nVisit this website<\/a> to read about how inflation and unemployment are related.\r\n\r\n<\/div>\r\n
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Fighting Recession or Encouraging Long-Term Growth?<\/span><\/h2>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\nNeoclassical economists believe that the economy will rebound out of a recession or eventually contract during an expansion because prices and wage rates are flexible and will adjust either upward or downward to restore the economy to its potential GDP. Thus, the key policy question for neoclassicals is how to promote growth of potential GDP. We know that economic growth ultimately depends on the growth rate of long-term productivity. Productivity measures how effective inputs are at producing outputs. We know that U.S. productivity has grown on average about 2% per year. That means that the same amount of inputs produce 2% more output than the year before. We also know that productivity growth varies a great deal in the short term due to cyclical factors. It also varies somewhat in the long term. From 1953\u20131972, U.S. labor productivity (as measured by output per hour in the business sector) grew at 3.2% per year. From 1973\u20131992, productivity growth declined significantly to 1.8% per year. Then, from 1993\u20132012, productivity growth increased to 2.2% per year. The neoclassical economists believe the underpinnings of long-run productivity growth to be an economy\u2019s investments in human capital, physical capital, and technology, operating together in a market-oriented environment that rewards innovation. Promotion of these factors is what government policy should focus on.\r\n\r\n<\/div>\r\n
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Summary of Neoclassical Macroeconomic Policy Recommendations<\/span><\/h2>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\nLet\u2019s summarize what neoclassical economists recommend for macroeconomic policy. Neoclassical economists do not believe in \u201cfine-tuning\u201d the economy. They believe that economic growth is fostered by a stable economic environment with a low rate of inflation. Similarly, tax rates should be low and unchanging. In this environment, private economic agents can make the best possible investment decisions, which will lead to optimal investment in physical and human capital as well as research and development to promote improvements in technology.\r\n\r\n<\/div>\r\n
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Summary of Neoclassical Economics versus Keynesian Economics<\/span><\/h2>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\nTable\u00a012.2 summarizes the key differences between the two schools of thought.\r\n
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Table\u00a012.2. Neoclassical versus Keynesian Economics<\/span><\/caption>\r\n
Summary<\/th>\r\nNeoclassical Economics<\/th>\r\nKeynesian Economics<\/th>\r\n<\/tr>\r\n<\/thead>\r\n
Focus: long-term or short term<\/td>\r\nLong-term<\/td>\r\nShort-term<\/td>\r\n<\/tr>\r\n
Prices and wages: sticky or flexible?<\/td>\r\nFlexible<\/td>\r\nSticky<\/td>\r\n<\/tr>\r\n
Economic output: Primarily determined by aggregate demand or aggregate supply?<\/td>\r\nAggregate supply<\/td>\r\nAggregate demand<\/td>\r\n<\/tr>\r\n
Aggregate supply: vertical or upward-sloping?<\/td>\r\nVertical<\/td>\r\nUpward-sloping<\/td>\r\n<\/tr>\r\n
Phillips curve vertical or downward-sloping<\/td>\r\nVertical<\/td>\r\nDownward sloping<\/td>\r\n<\/tr>\r\n
Is aggregate demand a useful tool for controlling inflation?<\/td>\r\nYes<\/td>\r\nYes<\/td>\r\n<\/tr>\r\n
What should be the primary area of policy emphasis for reducing unemployment?<\/td>\r\nReform labor market institutions to reduce natural rate of unemployment<\/td>\r\nIncrease aggregate demand to eliminate cyclical unemployment<\/td>\r\n<\/tr>\r\n
Is aggregate demand a useful tool for ending recession?<\/td>\r\nAt best, only in the short-run temporary sense, but may just increase inflation instead<\/td>\r\nYes<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n
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Self Check: Policy Implications: Inflation, Recession, and Unemployment<\/h2>\r\nAnswer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not<\/strong> count toward your grade in the class, and you can retake it an unlimited number of times.\r\n

You\u2019ll have more success on the Self Check if you\u2019ve completed the Reading in this section.<\/span><\/p>\r\nUse this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.\r\n\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/577\r\n\r\n<\/div>\r\n<\/div>","rendered":"

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Fighting Unemployment or Inflation?<\/span><\/h2>\n<\/div>\n<\/div>\n<\/div>\n

As explained in the unemployment section, unemployment can be divided into two categories: cyclical unemployment<\/em><\/a> and the natural rate of unemployment<\/em><\/a>, which is the sum of frictional and structural unemployment. Cyclical unemployment results from fluctuations in the business cycle and is created when the economy is producing below potential GDP\u2014giving potential employers less incentive to hire. When the economy is producing at potential GDP, cyclical unemployment will be zero. Because of the dynamics of the labor market, in which people are always entering or exiting the labor force, the unemployment rate never falls to 0%, not even when the economy is producing at or even slightly above potential GDP. Probably the best we can hope for is for the number of job vacancies to equal the number of job seekers. We know that it takes time for job seekers and employers to find each other, and this time is the cause of frictional unemployment. Most economists do not consider frictional unemployment to be a \u201cbad\u201d thing. After all, there will always be workers who are unemployed while looking for a job that is a better match for their skills. There will always be employers that have an open position, while looking for a worker that is a better match for the job. Ideally, these matches happen quickly, but even when the economy is very strong there will be some natural unemployment and this is what is measured by the natural rate of unemployment.<\/p>\n

The neoclassical view of unemployment tends to focus attention away from the problem of cyclical unemployment\u2014that is, unemployment caused by recession\u2014while putting more attention on the issue of the rates of unemployment that prevail even when the economy is operating at potential GDP. To put it another way, the neoclassical view of unemployment tends to focus on how public policy can be adjusted to reduce the natural rate of unemployment. Such policy changes might involve redesigning unemployment and welfare programs so that they support those in need, but also offer greater encouragement for job-hunting. It might involve redesigning business rules with an eye to whether they are unintentionally discouraging businesses from taking on new employees. It might involve building institutions to improve the flow of information about jobs and the mobility of workers, to help bring workers and employers together more quickly. For those workers who find that their skills are permanently no longer in demand (for example, the structurally unemployed), policy can be designed to provide opportunities for retraining so that these workers can reenter the labor force and seek employment.<\/p>\n

Neoclassical economists will not tend to see aggregate demand as a useful tool for reducing unemployment; after all, if economic output is determined by a vertical aggregate supply curve<\/em><\/a>, then aggregate demand has no long-run effect on unemployment. Instead, neoclassical economists believe that aggregate demand should be allowed to expand only to match the gradual shifts of aggregate supply to the right\u2014keeping the price level much the same and inflationary pressures low.<\/p>\n

If aggregate demand<\/em><\/a> rises rapidly in the neoclassical model, in the long run it leads only to inflationary pressures. Figure\u00a012.8 shows a vertical long-run AS curve and three different levels of aggregate demand, rising from AD0<\/sub> to AD1<\/sub> to AD2<\/sub>. As the macroeconomic equilibrium rises from E0<\/sub> to E1<\/sub> to E2<\/sub>, the price level rises, but real GDP does not budge; nor does the rate of unemployment, which adjusts to its natural rate. Conversely, reducing inflation has no long-term costs, either. Think about Figure\u00a012.8 in reverse, as the aggregate demand curve shifts from AD2<\/sub> to AD1<\/sub> to AD0<\/sub>, and the equilibrium moves from E2<\/sub> to E1<\/sub> to E0<\/sub>. During this process, the price level falls, but, in the long run, neither real GDP nor the natural rate of unemployment is changed.<\/p>\n

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\"The<\/p>\n

Figure 12.8.<\/strong> How Aggregate Demand Determines the Price Level in the Long Run As aggregate demand shifts to the right, from AD0 to AD1 to AD2, real GDP in this economy and the level of unemployment do not change. However, there is inflationary pressure for a higher price level as the equilibrium changes from E0 to E1 to E2.<\/p>\n<\/div>\n

 <\/p>\n<\/div>\n<\/div>\n<\/div>\n

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LINK IT UP<\/h3>\n

Visit this website<\/a> to read about how inflation and unemployment are related.<\/p>\n<\/div>\n

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Fighting Recession or Encouraging Long-Term Growth?<\/span><\/h2>\n<\/div>\n<\/div>\n<\/div>\n

Neoclassical economists believe that the economy will rebound out of a recession or eventually contract during an expansion because prices and wage rates are flexible and will adjust either upward or downward to restore the economy to its potential GDP. Thus, the key policy question for neoclassicals is how to promote growth of potential GDP. We know that economic growth ultimately depends on the growth rate of long-term productivity. Productivity measures how effective inputs are at producing outputs. We know that U.S. productivity has grown on average about 2% per year. That means that the same amount of inputs produce 2% more output than the year before. We also know that productivity growth varies a great deal in the short term due to cyclical factors. It also varies somewhat in the long term. From 1953\u20131972, U.S. labor productivity (as measured by output per hour in the business sector) grew at 3.2% per year. From 1973\u20131992, productivity growth declined significantly to 1.8% per year. Then, from 1993\u20132012, productivity growth increased to 2.2% per year. The neoclassical economists believe the underpinnings of long-run productivity growth to be an economy\u2019s investments in human capital, physical capital, and technology, operating together in a market-oriented environment that rewards innovation. Promotion of these factors is what government policy should focus on.<\/p>\n<\/div>\n

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\n
\n
\n

Summary of Neoclassical Macroeconomic Policy Recommendations<\/span><\/h2>\n<\/div>\n<\/div>\n<\/div>\n

Let\u2019s summarize what neoclassical economists recommend for macroeconomic policy. Neoclassical economists do not believe in \u201cfine-tuning\u201d the economy. They believe that economic growth is fostered by a stable economic environment with a low rate of inflation. Similarly, tax rates should be low and unchanging. In this environment, private economic agents can make the best possible investment decisions, which will lead to optimal investment in physical and human capital as well as research and development to promote improvements in technology.<\/p>\n<\/div>\n

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Summary of Neoclassical Economics versus Keynesian Economics<\/span><\/h2>\n<\/div>\n<\/div>\n<\/div>\n

Table\u00a012.2 summarizes the key differences between the two schools of thought.<\/p>\n

\n\n\n\n\n\n\n\n\n\n\n\n\n
Table\u00a012.2. Neoclassical versus Keynesian Economics<\/span><\/caption>\n
Summary<\/th>\nNeoclassical Economics<\/th>\nKeynesian Economics<\/th>\n<\/tr>\n<\/thead>\n
Focus: long-term or short term<\/td>\nLong-term<\/td>\nShort-term<\/td>\n<\/tr>\n
Prices and wages: sticky or flexible?<\/td>\nFlexible<\/td>\nSticky<\/td>\n<\/tr>\n
Economic output: Primarily determined by aggregate demand or aggregate supply?<\/td>\nAggregate supply<\/td>\nAggregate demand<\/td>\n<\/tr>\n
Aggregate supply: vertical or upward-sloping?<\/td>\nVertical<\/td>\nUpward-sloping<\/td>\n<\/tr>\n
Phillips curve vertical or downward-sloping<\/td>\nVertical<\/td>\nDownward sloping<\/td>\n<\/tr>\n
Is aggregate demand a useful tool for controlling inflation?<\/td>\nYes<\/td>\nYes<\/td>\n<\/tr>\n
What should be the primary area of policy emphasis for reducing unemployment?<\/td>\nReform labor market institutions to reduce natural rate of unemployment<\/td>\nIncrease aggregate demand to eliminate cyclical unemployment<\/td>\n<\/tr>\n
Is aggregate demand a useful tool for ending recession?<\/td>\nAt best, only in the short-run temporary sense, but may just increase inflation instead<\/td>\nYes<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n
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Self Check: Policy Implications: Inflation, Recession, and Unemployment<\/h2>\n

Answer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not<\/strong> count toward your grade in the class, and you can retake it an unlimited number of times.<\/p>\n

You\u2019ll have more success on the Self Check if you\u2019ve completed the Reading in this section.<\/span><\/p>\n

Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.<\/p>\n

\t