Answer to Question #128438 in Macroeconomics for chantelle

Question

The Humphrey–Hawkins Act of 1978 required that the federal

government maintain an unemployment rate of 4% and hold the

inflation rate to less than 3%. What does the inflation-unemployment

relationship tell you about achieving such goals?

Answer 1

Given the unemployment-inflation trade off suggested by the Phillips curve, it may be possible to hit a point on the curve such that both the unemployment and inflation targets are achieved.

However if the mandate is to hold unemployment at 4%, it is quite possible that for that rate to be viable, the inflation rate has to be higher than 3%. Or, if the inflation rate must be 3%, the unemployment rate must be more than 4%. If either of these situations exist, the government must take appropriate action through fiscal or monetary policy or both in order to realize these targets.

For example, if the current inflation rate is 3% but unemployment stands at 6%., something must be done to reduce unemployment. That can happen if aggregate demand is made to increase through either expansionary fiscal or monetary policy or both. However, when aggregate demand increases, inflation will rise above 3%. Consequently, to offset this development, the government should make attempts to increase aggregate supply. Aggregate supply will increase when the government implements supply-side instruments. Some policies which will encourage aggregate supply would be to subsidize the producers' costs, reduce capital costs of businesses through lower interest rates, reduce corporate profit taxes and so forth. Once aggregate supply rises to complement increased aggregate demand, the government will be able to attain both targets concerning unemployment and inflation.