Inflation and Unemployment

Read this chapter to examine the relationship between inflation and unemployment. As you will see, while there have been some periods in which a trade-off exists between inflation and unemployment, there are also periods in which such clear-cut negative relationship between these variables falls apart. The chapter offers some explanations for these variable behaviors and the stabilization policies that are used to address undesirable trends in the variables.

3. Inflation and Unemployment in the Long Run

Case in Point: Altering the Incentives for Unemployment Insurance Claimants

While the rationale for unemployment insurance is clear – to help people weather bouts of unemployment – especially during economic downturns, designing programs that reduce adverse incentives is challenging. A review article by economists Peter Fredriksson and Bertil Holmlund examined decades of research that looks at how unemployment insurance programs could be improved. In particular, they consider the value of changing the duration and profile of benefit payments, increasing monitoring and sanctions imposed on unemployment insurance recipients, and changing work requirements. Some of the research is theoretical, while some comes out of actual experiments.

Concerning benefit payments, they suggest that reducing payments over time provides better incentives than either keeping payments constant or increasing them over time. Research also suggests that a waiting period might also be useful. Concerning monitoring and sanctions, most unemployment insurance systems require claimants to demonstrate in some way that they have looked for work. For example, they must report regularly to employment agencies or provide evidence they have applied for jobs. If they do not, the benefit may be temporarily cut. A number of experiments support the notion that greater search requirements reduce the length of unemployment. One experiment conducted in Maryland assigned recipients to different processes ranging from the standard requirement at the time of two employer contacts per week to requiring at least four contacts per week, attending a four-day job search workshop, and telling claimants that their employer contacts would be verified. The results showed that increasing the number of employer contacts reduced the duration by 6%, attending the workshop reduced duration by 5%, and the possibility of verification reduced it by 7.5%. Indeed, just telling claimants that they were going to have to attend the workshop led to a reduction in claimants. Evidence on instituting some kind of work requirement is similar to that of instituting workshop attendance.

The authors conclude that the effectiveness of all these instruments results from the fact that they encourage more active job search.