Economic Policy and the Global Environment

Introduction

Inflation and unemployment are macro-economic factors which can adversely affect the operations of the economy if not controlled either in the short or long run. Inflation is the general increase in the price of goods and services in the economy. The types of inflation consist of demand-pull and cost-push inflation. On the other hand, unemployment is the situation in which people are actively looking for jobs and are willing to work but cannot find any. The types of unemployment consist of structural, cyclical, situational and natural unemployment. When any type of unemployment is experienced in an economy, there will be a decline in the living standards, purchasing power, slow growth rate, high dependency ratio and increase in poverty levels in the economy in the short run (Petroff, 2013). In a nutshell, a high inflation level erodes the value of the currency of the economy while a high unemployment rate leads to a decline in the total revenue which is to be collected by the government given the decrease in the number of employees who pay taxes. Therefore, it is the responsibility of the government to play an active role in managing the short run instability in the economy caused by inflation and unemployment problems. These can be achieved through the use of both monetary and fiscal policies.

How the government manages the short run instability caused by Inflation and Unemployment

In the short run, unemployment and inflation rates can be reduced by incorporating the monetary and fiscal policies to achieve equilibrium. If the expansionary fiscal policies such as an increase in the government spending and tax reduction are implemented by the government, a good environment will be created for business hence attainment of a high performance which leads to an increase in the employment level through the trickle down-effects. It is because, when the government involves in the business (by providing subsidies for example), the production costs of the business will decrease hence enabling them to charge low prices on the products which they supply in the market, a situation which shall attract a large pool of consumers (Hibbs, 2009). As demand increases, the companies will respond to this pressure by hiring more workers and expanding in scope to meet the increasing demand. These will assist in the improvement of living standards of the people over time. It will also assist to improve the consumers' living standards as well as eliminating the level of dependency ratio caused by poverty. Besides, the government can reduce the level of unemployment by adopting policies which limit the companies from laying off workers from their duties over a given period. When this happens, the workers will get an opportunity to work, a process which shall reduce the level of unemployment in the short-run. Also, the government should increase the export competitiveness to provide an injection of demand in the circular flow of income hence balancing the entire stakeholders' in the economy. Moreover, the government can provide work incentives by introducing work-pay mechanisms to reduce the benefits dependency and expand the level of the labor supply in the labor market, a process which shall increase the level of unemployment in the short-term basis. Other factors which can be used to reduce the level of unemployment include the incorporation of the stimulus on demand from both the private and public sectors to keep the aggregate demand high hence driving the creation of new jobs in the market. These will ensure that the employment levels are maintained at an equilibrium level hence stability in the economy.

On the other hand, government can reduce the level of inflation in the short-term, they can set-up a price ceiling and price floors to ensure that the prices which are charged in the market are maintained at a manageable level if not equilibrium hence assisting the economy given that the demand for goods will not be affected by the price fluctuations which can be experienced in the market over a given period. On the other hand, the central bank can incorporate or implement the expansionary monetary policies such as increase in the money supply, reduction of the interest rates, and removal of the loan access restrictions in loan which shall aid individual citizens to attain loans from banks and financial institutions hence an increase in employment level through trickle-down effect as well as improvement in the government revenue collection over time. When these are done, it will assist in reducing the level of unemployment experienced in the economy by a bigger margin in the short-run.

In the state of the United Kingdom, for example, the economy tried to respond to 2008/09 recession by the use of the expansionary monetary policies. The Bank of England did cut the interest rates so as to boost the economic recovery by increasing the level of general demand. The lower interest rates enabled the people to borrow to encourage firms and individuals to borrow to invest while the consumers are encouraged to spend. These improve the productivity of the firms and individuals, a process which leads to an improvement in the economic performance over time. Besides, the low-interest rates tend to reduce the cost of mortgage interest repayments a situation which gives most of the households a higher disposable income which enables them to spend more on goods and services. These improved the performance of the economy hence leading to the incline in the performance of the economy over a given period. Besides, the government uses the quantitating easing policies so as to increase the money supply. Under this policy, the government creates money and uses it to buy government bonds from the commercial banks. These tend to increase the rate of lending; a process which improved the operations and performance of the people in the United Kingdom as far as entrepreneurship is concerned ("Inflation and Unemployment," n.d.). These improve the level of employment as well as maintaining inflation at manageable levels.

The expansionary monetary policies can cause economic growth and assist in lowering the unemployment rate experienced in the economy. Even though it can cause a higher inflation, its application should be regulated so as not to adversely affect the consumers. However, in the United Kingdom, the expansionary monetary policies which were implemented in the year 2008/09 recession did help to restore the economy from recession. Even though the economy was still weak as it was expected, the country was going on better and it was moving in a positive direction.

However, during the implementation of the policies, the government should take into consideration the relationship between the unemployment and inflation rate. In accordance with Philip's analysis, there is an inverse relationship between the rate of unemployment and inflation. The theory postulates that when the demand for labor increases, the employers will be bidding high wages to attract more qualified workers in their firms (Drazen & Helpman, 2010). On the other hand, when the demand for labor decreases and the unemployment is high, workers will be readily available to accept lower wages, a situation which can lead to the exploitation of workers in the labor force. It thus means that as the level of inflation increases, the level of unemployment tends to decrease and vice-versa. It thus implies that the full employment and low inflation are some of the key cornerstones which should be considered when implementing the monetary policies in managing the economic problems caused by the inflation and unemployment (Drazen & Helpman, 2010). These will guarantee the policymakers an opportunity to achieve price stability and maximum stable employment. It is the trade-off which exists between unemployment and inflation which have enabled most governments to utilize Philip's curve to fine-tune the monetary and fiscal policies the policies which they want to use. It is because it provides a balance between the level of unemployment and inflation which is recommended in the economy.

The theory which was developed by Philip makes a good theoretical sense to most of the users and economic experts. It is because it makes a prediction that due to inflation, the economy can experience both the inflationary and recessionary gap. When the economy has a recessionary gap, they will tend to have a high level of unemployment with little to no inflation. On the other hand, when an economy experiences an inflationary gap, it means that there is little to no unemployment with a high level of inflation in the economy (William C. Spaulding, n.d.). Therefore, when the economists use Philip's curve theory in their decision-making process, they tend to get a smooth transition between the two problems so as to attain equilibrium in the good and labor market.

Conclusion

In conclusion, it can be evident that the government has a responsibility to ensure that they reinstate stability in the economy by setting up policies which aim at improving or solving the unemployment and inflation problems. When the unemployment and inflation rates are not reduced, they can lead to the increase in the poverty level, decrease in the purchasing power of the consumers, an increase in dependency ratio and a decrease in the living standards both in the short or long-term basis. To attain these, the government should use expansionary monetary and fiscal policies to move the economy out of the recessionary gap. On the other hand, the use of the provision of subsidies and tax cut can also lead to the erosion of the inflationary gap. However, for equilibrium to be obtained, Philip's curve theory should be taken into consideration.

References

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Drazen, A., & Helpman, E. (2010). Inflationary consequences of anticipated macroeconomic policies. The Review of Economic Studies, 57(1), 147-164.

Hibbs Jr, D. A. (2009). The mass public and macroeconomic performance: The dynamics of public opinion toward unemployment and inflation. American Journal of Political Science, 705-731.

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William C. Spaulding. (n.d.). Inflation and Employment. Retrieved from https://thismatter.com/money/banking/inflation-and-employment.htm