Interest rates and unemployment Nov.2005

Interest rates and unemployment Nov.2005

In reviewing my blog which began in early November 2005 I have discovered that several of my original blog entries have somehow been deleted and tampered with. Fortunately I have hard copy of them and since what I said at the time almost five years ago turned out to be quite accurate and relevant I am going to reproduce it here again for the record.

My first blog entry in early November of 2005 read as follows except for the material in brackets which I have added now to avoid confusing readers):

Don't raise the rate of interest and let's target 5 % unemployment.

The news that Canada's unemployment rate has dropped to 6.6 % is welcome news.( that was the rate in the fall of 2005) But there is a dark cloud that may spoil the picture. The Bank of Canada continues to be stubbornly tied to the discredited notion that inflationary expectations get underway whenever unemployment falls below the natural rate of say 7 %. So even though once we factor the OPEC oil cartel out of the picture inflation remains very low and well under control the Bank stubbornly clings to the idea that interest rates should be raised to nip the falling unemployment rate in the bud. this pernicious doctrine ignores the reality that manufacturing employment in Ontario is being damaged by too high an exchange rate on the Canadian dollar vis a vis the American which is clear when we examine the details of the unemployment numbers. Whenever the Bank pushes up interest rates this has the effect of pushing up the value of the dollar and thereby killing jobs in the export industries. While unemployment is nicely falling in the energy rich West it is still too high in Ontario and Québec.

It would be a smart move for Prime Minister Paul Martin (the Liberal P.M. before conservative Stephen Harper) and Finance Minister Ralph Goodale to send word to David Dodge over at the Bank of Canada to revise his thinking and not raise rates. (David Dodge was the central bank Governor prior to Mark Carney)If he did not unemployment might well drop to 6 % and perhaps below. This would inject a major increase in income, help reduce poverty, and swell the tax revenues of the Federal government enabling further debt reduction, program investment in health care, infrastructure and education and a welcome tax cut as well.

Instead of basing policy on the discredited doctrine of the natural rate of unemployment how about basing it on the natural rate of inflation. If you try and push inflation below too low a level you generate rising and chronic unemployment. the consequence of this is that once unemployment begins to fall the economy can tolerate a much lower rate of unemployment before there is a problem with inflation. Globalization has had an anti-inflationary impact because of all the cheap imports and the use of internet technology to source just in time production.(See my paper RESTORING FULL EMPLOYMENT:THE NATURAL RATE OF INFLATION
VERSUS THE NATURAL RATE OF UNEMPLOYMENT
Paper presented to the Conference on Social Policy as if People Matter, Adelphi
University , Garden City , New York, Nov.12, 2004.reproduced on the net by the Conference organizers.)

In addition to targeting low unemployment once you accept that the oil cartel is the only source of inflationary price pressure this strategy off demand stimulation is actually capable of generating anti-inflationary increases in output that remove bottlenecks, weaken cartels and positively stimulate the economy. Its time for some fresh thinking in public policy economics. How about starting now.(end of the original Nov. 2005 entry)

Well a great deal of water , indeed torrents of it has flowed under the bridge since then. But I stand behind what I wrote then. Most of the central banks have improved their thinking and are less dogmatically wedded now to the natural rate of unemployment doctrine. This is particularly true of the American Fed under Ben Bernanke. But they have not totally seen the light and certainly the Bank of Canada still lags behind in its thinking. The recent resurgence of sound finance doctrine and dogma particularly at the European central bank is evidence of how much further we have to go. The crash and its aftermath coupled with the policies then in place have pushed global unemployment sharply up from what it was in 2005. It will take further bold fiscal measures and a continuance of the policy of monetary accommodation to get the results that are needed on the employment front.