Unemployment vs. Inflation: Which is Worse? Part I

Macro economic policy making is often characterized as a trade-off between achieving full employment vs. achieving stable money (no significant inflation). This relationship or trade-off,to the extent it exists, is called the Phillips Curve.  [note: the stability and existence of a long-run trade-off is highly contested by some]. In this post, I want to look at the costs of missing our objectives on either.

In my macro classes I like to emphasize that an economy, any economy, wants to achieve at least 4 major objectives through policy:

  1. Overall growth (long run trend growth in GDP)
  2. Short- and Medium-run stability of growth (minimize the business cycle)
  3. Stable monetary and financial system (no significant inflation, no deflation, no financial crises)
  4. Full employment

Of these, it is often perceived that achieving both #3 and #4 may be problematic since the easy policies to achieve either run the risk  of making the other worse.  It is possible to achieve both, but it’s more tricky and requires more accurate policy moves. That brings us to the question of which way is the more serious error?  Not all dilemmas are symmetrical.  In other words, if we’re likely to make an error, which error should we prefer?  Yes, we may be stuck “between a rock and a hard place”, but if the hard place is material that’s likely to absorb some impact and let us survive with injuries, while hitting the rock represents certain death, I would definitely prefer policies that, if they are wrong, they tend to lead to the hard place over the rock.

So which is worse?  The rock of high unemployment?  Or the hard place of inflation?  In this post, I’ll offer some evidence for why high unemployment is the more costly problem.  In a later post, I’ll look at the costs of inflation.  For now let’s look at the costs of high unemployment below the fold:

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