Magazine article Management Today

Unemployment Takes on an Inflated Importance

Magazine article Management Today

Unemployment Takes on an Inflated Importance

Article excerpt

Unemployment takes on an inflated importance So Britain is finally in the ERM. Even those of us who wanted her to join many years ago can give only two cheers. The timing is too obviously political. Membership of the ERM, and the reduction of inflation to a German level of 2-3%, require the continuance of a tough monetary and fiscal policy, and whether this will happen in the run-up to the election is uncertain.

The central rate for the pound has been set at 2.95 DM, with a range of 6% on either side. If the rate is in danger of going outside the range, the members of the ERM will intervene, but the Government can change the central rate if it wishes. Thus ERM membership is only meaningful if the Government is determined to maintain the pound within the 6% range (and to move before long to the normal 2 1/2% range), and if financial and labour markets are convinced of the Government's determination. If we assume that it is so determined, what are the potential economic benefits and dangers?

The potential benefit is that a fixed exchange rate will have an anti-inflationary impact by exerting pressure on wage negotiations. Exporters will know that they will not be bailed out by devaluation if they concede wage increases above a German level of say, 5%, and trade union representatives will know that inflation will not be aggravated by devaluation. The experience of France and Italy, which brought inflation down in the 1980s and kept it down more successfully than Britain, suggest, however, that the process is slow and difficult, and accompanied by higher unemployment. Unemployment in Britain is already rising, and may well rise by some 400,000 over the next two years.

However, Britain would almost certainly have faced higher unemployment whether inside or outside of the ERM. Economists have long recognised that overcoming inflation nearly always means a temporary rise in unemployment, and the idea has been resurrected in the theory of 'Nairu' (Non-accelerating-inflation rate of unemployment). For any given state of the labour market there is (allegedly) a rate of unemployment which will produce price stability, or a low and stable rate of inflation (eg.2%). If unemployment falls below Nairu, there will have to be a temporary rise above it, before a return to the original level.

Most economists accept that there is something in this theory, but it does not follow that Nairu is immutable; it can be lowered by improvements in the efficiency of the labour market. Nor does efficiency necessarily involve neo-liberal prescriptions such as the elimination of trade unions. Germany and Sweden have more powerful trade unions than Britain, but their record on the trade-off between inflation and unemployment is better. What, therefore, are the flanking policies which could assist ERM membership by bringing down inflation while minimising the rise in unemployment?

There are at least two such policies, the first of which is confidence in the central bank. Monetary policy has a permanent effect on wage-bargaining only when everyone knows that the institutions in charge of monetary policy are committed to price stability. The countries which have been most successful have either an independent central bank committed to price stability (Germany, US), or an administrative culture which achieves a similar result (France, Japan). …

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