To what extent should full-employment be the main macro policy objective?

Promoting fulfilling work that generates a flow of earned income sufficient to live and raise a family is for many people one of the defining characteristics of a decent society.

The UK government does not have a specific target for unemployment in contrast to the 2% CPI inflation target given to the Bank of England as an anchor for the setting of domestic monetary policy. Neither does the government publish a clearly-stated economic growth target. So should unemployment take precedence in the setting of macro policy and specifically an ambitious target for reaching and maintaining high employment as close as possible to full-employment?

The case for elevating full-employment as a top priority of macroeconomic policy rests on understanding the economic and social costs that flow from having large number of people out of work especially for an extended period. Unemployment hits families, localities, regions and the wider economy. There is firstly the narrow economic cost of lost output since labour hours represent a scarce resource that can never be recovered. High unemployment leaves national output well below potential and can also lead to deflationary pressures on prices ands wages. Consider the struggles that Greece has faced over the last decade as a stark example of the economic distress that comes from mass unemployment and price deflation.

Rising unemployment also hits the government’s own finances as direct & indirect tax revenues contract and demands for welfare increase. This leads to a higher fiscal (budget) deficit and increasing levels of national debt which ultimately affect the majority of taxpayers across generations.

And then we can consider the social / human impact of unemployment. Having a routine job and a regular income is fundamental to enjoying economic freedoms. Long-term unemployment causes skills to depreciate and eats away at the motivation to engage in job search for those affected. Areas of high economic deprivation suffer from worsening outcomes across a range of social indicators. Years of active life expectancy decline, exposure to high-interest rate debt grows and young people growing up in families perhaps with no-one in full or part-time work suffer from worsening nutrition and weaker educational outcomes. There are numerous negative externalities from prolonged and significant levels of unemployment.

Maintaining high employment can be justified on both economic and social grounds. Equally the emphasis should be on providing good, fulfilling and meaningful work - an aspect covered in depth by the Taylor Review published in 2018.

To what extent should low unemployment come ahead of other macro objectives? It is inevitable that value judgements are involved when ranking one objective over another.

For some economists, maintaining a stable and low positive rate of inflation is given high priority. The argument runs that accelerating inflation can be damaging both to competitiveness and ultimately to jobs and real incomes. The consensus view that an inflation rate of between 2-3 percent is close to being optimal has by-and-large become embedded in macroeconomic policy making over the years. Hence the price stability target given to the Bank of England and other central banks around the world. Some countries, especially faster-growing emerging markets countries, have a higher inflation target. For example, China targets inflation of around 3 percent; India’s inflation target is 4 percent +/- 2 percent, whilst Nigeria seeks to keep inflation between 6-9 percent and Vietnam has a point target of 5 percent.

One of the risks of focusing policy on cutting unemployment to very low levels is that it risks causing a burst of demand-pull and cost-push inflation which - in the medium term - will stifle economic growth and reduce employment and real incomes. Clearly a fine balance might have to be struck. One problem is that it is hard to estimate the NAIRU - the non-accelerating inflation rate of unemployment which - in lay people’s terms - is the rate of joblessness consistent with a given stable rate of inflation. Those economists concerned about inflation risks would err on the side of caution and encourage central banks to tighten monetary policy via higher interest rates and a tapering of quantitative easing, well before actual and expected inflation take off. Another group of economists argue that the fast-changing nature of the labour market in the UK, United States and other countries means that unemployment can indeed fall further without triggering a steep pick up in inflation.

Consider the UK for example where officially the LFS measure of unemployment is just 4.2 percent of the labour force, where employment is at a record high and where there are almost as many unfilled job vacancies (800,000) as people who have been out of work for 1-6 months. By this point in previous economic cycles, we would have expected consumer price inflation to have risen quite sharply and the central bank to have raised interest rates to slowdown the growth of aggregate demand.

Instead, bank base rate remains at 0.75 percent and very few economists expect any major tightening of monetary policy in the near-term (not least because of uncertainty over the impact of a disorderly Brexit on demand, investment and jobs). There has been a burst of academic interest recently in whether the Phillips Curve has flattened. The conventional Phillips Curve analysis suggests a non-linear relationship between unemployment and inflation and predicts that, when the jobless level falls below a certain rate (the NAIRU), then higher cost and price inflation is likely to follow. This implies a trade-off between unemployment and inflation as macro objectives.

But if the Phillips Curve has flattened or perhaps shifted inwards, then the rate of unemployment consistent with stable inflation will have fallen and policy-makers would more easily be able to align policies towards increasing employment without the fear of inflation climbing to unsustainable levels.

Full-employment might also come into conflict with other macro aims such as a sustainable position on the current account of the balance of payments. A strong labour market with real wages rising feeding through to increased domestic consumption could lead to a faster growth of imports and a widening of a current account deficit. However, for most countries, financing an external deficit is not problematic. The UK for example remains a favoured venue for foreign direct investment and substantial inflows of portfolio investment into debt and equity markets. Add to this there argument that stronger aggregate demand can lead to increased planned capital investment through a positive accelerator effect which - in the medium term - will increase a country’s productive capacity and supply-side competitiveness which can then help to improve the net trade balance.

Economic cycles are inevitable as are external shocks to both aggregate demand and supply. So a narrow target for maintaining full-employment might have to be adjusted for the stage of the cycle. But this essay argues that good quality jobs, sustainably balanced across regions and which pay well enough to lower the risk of in-work poverty should be given priority in macroeconomic policy-making. The UK is no longer a high inflation country and policy objectives should reflect this changing reality.