Sunday, January 12, 2014

Inflation and Unemployment

Here’s a cool interactive graph from The New York Times. It plots the inflation and unemployment rates against each other over the last 85 years, and then lets you highlight 7 different episodes (it’s interactive, so you much click through to play wit it).

Be careful in your interpretation: 1) unemployment is definitely worse as you go to the right, but 2) both inflation and deflation are problems, so the best spot is along the horizontal axis rather than at zero.

Why just above zero? Economists have told politicians to prefer a little inflation to a little deflation. The reason is that inflation makes your employees cheaper in real terms, while deflation makes them more expensive. Since a lot of our adjustment in labor is through firing people, it makes sense to bias a little away from that. How far: most people tend to think 1-3% is a tolerable inflation rate. The gray horizontal line in the graph is at 2%.

With unemployment, there’s a limit to how low we can go. Given current demographics (i.e., a larger than typical proportion of young people in the labor force), it seems sensible to think that 5% is about as low as we can go. The New York Times is less optimistic (or they’re trying to set a lower hurdle for Obama to reach): they’ve put the vertical line at 6%.

The chart puts things in perspective: we may complain a lot, but we’re not far off the best we can hope to be, and we’re considerably closer than in much of the last 85 years.

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