Wednesday, November 24, 2010

Unemployment Target

In the past few months, UK inflation has been marginally above the Government's target of CPI - 2% +/-1. When inflation is slightly above target, there is often fierce criticism and claims that the Bank of England are failing to do their job.

But, why do we not have an unemployment target, which is given just as much priority? Most economists would argue full employment is somewhere around 3-4% (some would say lower, some would argue higher). But, for simplicity suppose we had an unemployment target of 4%. Each month, if unemployment was above the target the Bank of England would have to write a letter of explanation.

Both unemployment and inflation are important. The danger is that sometimes commentators and economist act as if inflation is the only thing that matters.

Central Bankers do need room for manoeuvre. Just before the great recession, we saw inflation rise to 5%, yet, these cost push inflation factors proved temporary and misleading to the real state of the economy.

An unemployment target doesn't mean we can become blaze about inflation and allow inflation expectations to rise. Maintaining low inflation does help economic stability and investment in the long term. However, if we had an unemployment target, it would make it easier for MPC to explain why they aren't over-reacting to slightly higher inflation. It would help central banks to gain more perspective. The ECB don't want to consider quantitative easing because of 'inflationary risks' but they are presiding over a deep economic slump and mass unemployment. If they had to consider an unemployment target, they would have a broader of perspective.

Economics requires flexibility, you can't stick to targets with religious devotion when more pressing problems are occurring.

Given that:
  • The UK has experienced the deepest recession since the 1930s,
  • Unemployment approaching 10%
  • Inflation rates in other countries is low
  • Prospect for fiscal tightening in the new year.
I don't see any reason to get too worried about inflation that is slightly above target. I would be much worried at the US and European situation where inflation is heading towards the lower end of the target.

I would love the ECB to adopt an unemployment target as they often place too much stress on the mythical importance of price stability above other concerns. This would help those economies struggling under a weight of austerity but having no help from the ECB.


1 comment:

Basudeb Sen said...

A novel idea of the monetary authority targeting unemployment rate! If tthe central bank has to target inflation rate and unemplyment ratesimultaneously, it has to fail much more often than suceed. If there is any theoretical and / or empirical relationship between unemployment and inflation rate, the monetary authoprity is better placed to target inflation rate or price index as it can operate with monetary tools available and unemploymenbt rate will be automatically targeted as given by the established relationship. If there is no relationship (equation) between inflation rate and unemloyment rate, then targetting both would demand more levers than what the monetary authorites enjoy and therefore bound to fail. Unemployment rate depends on economic growth rate and labour intensity of increnental investment as permitted by technology that is commercially attractive. Monetary authorities hve very littkle in their arsenal to impact technological development, choice of technology and mix of labour intensive investments.
We must have a solid econmic theory to justfy what we prescribe for the Ban og India to target!!