Economic Nonsense: 11. Inflation is a price worth paying to boost employment


It used to be thought there was a trade-off between inflation and employment.  The economist William Phillips published a 1958 paper in which he found an inverse relationship between money wage changes and unemployment over nearly a century.  The relationship was called the Phillips Curve, and was used by legislators to stimulate the economy by inflation to boost employment rates. Unfortunately the Phillips Curve went vertical in the 1970s as countries were beset by high inflation and high unemployment occurring simultaneously.  People were building expectation of inflation into their calculations and their economic decisions.  Inflation rewards debtors at the expense of creditors and makes people less ready to lend.  Investment in productive activity diminishes.

No less seriously, the assumption of future inflation makes forward planning difficult.  People do not know what money will be worth by the time their goods reach the market.  What inflation does do is cause misallocation of resources.  People see the new money created by government and make false assumptions about what they should invest in.  When they find that the demand was unreal, goods go unsold and there is an economic downturn with increased unemployment.  This brings about the 'stagflation,' in which high inflation and high unemployment happen together.

Inflation can reduce unemployment in the very short term, but only at the expense of more unemployment following afterwards.  This is why some governments have boosted inflation in an election year to take advantage of the apparent stimulus, then face the recessionary consequences after the election is safely out of the way.  The strategy is now called boom and bust because an inflationary boom is followed by a real-world bust.