The institutional underpinnings of the unemployment-inflation relationship: a review paper

by MICHIE, J., 2003
Research Report, Employment Growth & Development Initiative, Human Sciences Research Council

“Michie examines the institutional underpinnings in the relations between unemployment and inflation. This is a central question for policy makers in solving significant structural unemployment gaps: interventions to stimulate the economy can often lead to inflationary impacts unless the institutional environment enables the required response by firms to invest and ultimately generate more employment. He first reviews the theoretical literature. The Phillips curve, which underpinned public policy during the 1960s and 1970s, depicted a trade-off between unemployment and inflation. This was replaced in the 1980s by monetarism and the associated ‘natural rate of unemployment’, which posited no long-run trade-off between unemployment and inflation. Later, the ‘Non-Accelerating Inflation Rate of Unemployment’ (NAIRU) allowed only one rate of unemployment at which inflation would be stable, but also recognised that wage and price setting are influenced by market structure and power. It therefore recognised the role of active labour market policies in reducing unemployment Michie considers a number of institutional interventions that could shift the relationship between unemployment and inflation. He discusses: • The mechanisms through which interest rates affect the economy • How corporate investment decisions could be influenced to enhance productive capacity • Market concentration in key industries • Labour market segmentation and active labour market policies • Unemployment, wage growth and productivity “