Can an Economy Achieve Low Unemployment, Low Inflation, and Economic Growth at the Same Time?
It is a dream scenario for policymakers and citizens alike: an economy that can simultaneously boast low unemployment, low inflation, and robust economic growth. However, would Trump’s approach suffice for maintaining such a balance? Or is there more to it than merely cutting regulations and taxes?
Understanding the Complexity
Both previous answers assumed a steady-state situation, yet real-world economies rarely remain stable. My experience in observing economies over a lifetime has shown that these ideal states are temporary. Whenever a balance of low unemployment, low inflation, and economic growth is achieved, it only lasts until the congratulations are said!
Businesses continuously strive to innovate and adapt to drive down unemployment and boost growth, often focusing on increasing productivity through advanced technology and innovative tactics. However, this relentless drive for progress also leads to lower wages, which is a crucial point of differentiation from popular belief. Contrary to common understanding, inflation is primarily driven by credit creation, not by rising wages.
Tackling the Guidance Game
The inherent challenge in coordinating these economic indicators is how to balance them while achieving desired outcomes. The truth is, you don't need to perfectly coordinate everything. Instead, economies naturally cycle through periods of stability and flux, and when it seems like equilibrium is reached, it often disappears just as quickly as it appeared.
Illustration: Just like a pendulum, the economy swings between extremes. Moments of perfect harmony between unemployment, inflation, and growth are short-lived, making them temporary and often fleeting.
The Role of Policy and Central Banks
One way to achieve a balance is through policy and central bank actions. The Phillips curve, which illustrates the trade-off between inflation and unemployment, is a crucial tool in this context. If a central bank aims for low inflation (around 2%), it can facilitate both low inflation and low unemployment (full employment) through credible policy measures. Here's how:
Credibility and Stability
A central bank with a credible policy can anchor market, business, investor, and consumer expectations to its inflation target. This means that when unexpected economic shocks occur, inflation expectations don't spiral beyond the target, minimizing the impact on unemployment. In 2001, the Federal Reserve demonstrated this when it aggressively cut interest rates from 6.5% to 1.75% to cushion the impact on aggregate demand and employment. This action would have been challenging if inflation expectations were not anchored due to a lack of central bank credibility.
Practical Example: Marvin Goodfriend's work illustrates the impact of credible central bank policy, showing that low inflation and full employment can coexist with proper policy implementation.
Heterodox Approaches and Labor Costs
An alternative approach emphasizes the role of labor costs in driving inflation. High labor costs can lead to wage-price spirals, as exemplified in the U.S. during the 1970s. James Kenneth Galbraith advocated for wage controls to reduce inflation. Before the Phillips curve, the Sultan curve demonstrated the trade-off between wage inflation and unemployment. Thus, wage moderation can help to keep inflation in check.
Key Insight: By ensuring wage restraint, the Phillips curve becomes steeper, facilitating more robust full employment policies without significant inflation spikes. This configuration can lead to low unemployment, low inflation, and strong economic growth.
The Swedish Model
The traditional Rein-Meider Swedish model offers another framework. This model included centralized and coordinated wage bargaining between labor unions and employer organizations, as well as the state commitment to anti-inflationary policies. These measures were further supported by active labor market policies (ALMP) and other policy measures. This collaborative approach helped to maintain low inflation and full employment.
Conclusion: While achieving low unemployment, low inflation, and economic growth simultaneously is no small feat, it is achievable through well-coordinated policy measures and central bank credibility. By understanding the complexities and employing various strategies, policymakers can strive for a more stable and prosperous economic environment that benefits all.