The “relationship” between unemployment and inflation that traps the strategy of Central Banks

This scheme argues that what causes inflation is basically an increase in demand, that is, when there is more demand in the market for goods and services which in turn increases prices and therefore inflation.

A key aspect of this pattern of increased demand is that it has to do with the ability of workers to have increased bargaining power and thus demand higher wages and salaries, with which to feed the increased demand.

And this increased bargaining power has to do with the labor market being “tight”, that is, there is not a high unemployment rate, businesses are looking for workers, and every worker who walks through an employer’s door will be able to demand a comparatively higher wage, which he will take him because his employer needs him.

Consequently what is needed for the unemployment rate to rise is for the economy to effectively enter a recessionary condition. This will be done by rising interest rates that will limit available liquidity and make the cost of borrowing more expensive for businesses, forcing them to cancel additional investments or ‘openings’. In a more restrictive environment, companies are forced to reduce their staff, so there are layoffs instead of hiring, unemployment increases, workers have insecurity and accept to work for lower wages, so that excess demand is limited and therefore those who sell goods and services should be forced to drop prices, or at least to stop raising them, and thus to contain inflation.

After all, we should not forget that for a long time the unemployment rate that does not increase inflation (in the sense that if it falls below we have inflation) has been a key concept in economics.

This scenario seems to be what the central banks, led by the American Fed, want to implement now, with successive interest rate hikes until the eventual favorable recessionary dynamic takes shape.

Is the job market really that “tight”?

But the data, first and foremost in the US, show that the labor market situation is somewhat more complex. In practice, however, the repeated statement that the American market is characterized by a high demand for labor, which in turn increases the bargaining power of workers, is misleading.

What is true is more of a real worker shortage that has to do with the fact that a large number of workers did not return to the labor market after the pandemic. This has to do in part with continued health problems from the pandemic, mainly to do with far more retirements, which contribute 2 to 3.5 million positions to the shortages seen, and which have to do with the selection of workers whose work has been interrupted their relationship to the pandemic and they were already of a certain age to prefer retirement to looking for work.

Additionally, the pandemic itself and the deaths from it combined with the large decline in immigration to the US have also played a role in this current labor shortage. It is estimated that the combination of these two factors could contribute up to 1.5 million additional job shortages.

In addition, it should be noted that most of the new jobs created recently in the US have been largely part-time, while significantly more permanent jobs have been lost. At the same time, he emphasizes that at the moment even the upward trend in hiring seems to be receding.

All of this means that it is very difficult to argue that the driver of inflation at the moment is the fact that there is enough unemployment to weaken the bargaining power of workers.

The reasons that increase prices and inflation

On the basis of complex technical analysis it shows that it is not labor costs that drive up prices. Instead, other costs, such as energy, and the tendency of businesses to increase prices to increase profit margins (profit markups) play a role.

Conversely, any relatively small increases in nominal wages do not keep pace with inflation, resulting in a downward trend in real wages.

After all, any small declines in inflation recorded in some countries recently probably have to do with the improvement of things on the supply side, e.g. by solving problems in supply chains, rather than by some reduction in demand due to rising unemployment.

Being trapped in a traditional way of thinking

All this confirms the problem with how central banks and financial staffs remain locked in a way of thinking that belongs to other times and other circumstances.

This means the real danger of having “restrictive” policies that ultimately fail to achieve their anti-inflationary objective, while creating various other problems.

But also the real difficulty of an anti-inflationary policy that will have to collide with the way markets are organized, the problems in international supply chains and of course the perception of businesses about the minimum levels of profitability.

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