Unemployment, inflation and some relevant policy issues

Abstract

This thesis is an attempt to consider in some detail a few of the important theoretical and policy issues associated with unemployment and inflation, using a fairly standard framework which many economists would accept as plausible. Part 1 is concerned with "The Role of Expectations and Deficit Financing." Here we introduce the rational expectations approach to economic modeling and also show how the short-run responses of endogenous variables can be calculated. We do this in conjunction with an examination of the stability properties associated with alternative forms of deficit financing. In Parts 2 and 3 of the thesis we use the techniques developed in Part 1 to examine some policy issues more closely. Frequently, a government policy maker may want to lower both inflation and unemployment in a manner which is as painless as possible. One solution to the policy maker's problem is presented in Part 2, entitled "Optimal Stabilization Policies Under Perfect Foresight." Here we formalize the policy maker's objective and discuss what policy instruments can be used to achieve that objective. We also spend some time discussing whether it is desirable for prices to jump and if this is the case what is the magnitude of the appropriate jump. Time consistency of the optimal solution is also considered. "Some Relevant Policy Issues" are discussed in Part 3. When unemployment becomes high, two issues that are frequently raised concern "easy" methods for lowering unemployment and ways of relieving the hardship of the unemployed. One method of lowering unemployment is by lowering the length of the standard working week and hence lowering the aggregate supply of labor. A way of making life more acceptable to those who are unemployed is by paying higher unemployment benefits to those without work. Both these "solutions" are examined in Part 3. An important part of this thesis is the way in which the issues mentioned above have been analysed within a consistent framework of models. This framework provides a common thread which, along with the common theme of the issues discussed, unifies the thesis into a coherent whole.