We can see that unemployment and recessions impose great costs on societies. Yet countries do not today employ their monetary and fiscal powers to reduce unemployment to minimal frictional levels. While countries proclaim the importance of work over welfare, they tolerate high levels of unemployment. Moreover, than output approaches its potential, as occurred in the United States in 1994 and again in 1997, central banks often begin to raise interest rates and slow the expansion. If unemployment is so costly, why do countries not use demand policies to get rid of it?
The reason is simple. Extremely high levels of capacity utilization and low levels of unemployment create shortages in a market economy. As a result, inflation soon rises to intolerable levels.
In fact high inflation has been contained in high-income countries over the last decade. But low inflation in Europe was accompanied by steadily rising unemployment. Moreover soaring, prices have plagued many developing countries that relied too heavily on the printing press to finance government spending. Recently as formerly centrally planned countries took steps to free prices and make the transition to the market, they found their price levels increasing rapidly.
The reason is simple. Extremely high levels of capacity utilization and low levels of unemployment create shortages in a market economy. As a result, inflation soon rises to intolerable levels.
In fact high inflation has been contained in high-income countries over the last decade. But low inflation in Europe was accompanied by steadily rising unemployment. Moreover soaring, prices have plagued many developing countries that relied too heavily on the printing press to finance government spending. Recently as formerly centrally planned countries took steps to free prices and make the transition to the market, they found their price levels increasing rapidly.