By Bill Davis

February 8, 2024


The Phillips Curve shows the tradeoff between lower inflation and higher unemployment

And why does it matter?

Full employment is a cornerstone concept in economics, representing a state where all available labor resources are effectively utilized within an economy. Yet, the interpretation and implications of full employment have evolved significantly over the decades, reflecting shifts in economic policies, labor market dynamics, and the broader global economic landscape. This post delves into the nuances of full employment, exploring its definition, measurement, and the changing perspectives on what constitutes full employment over time.

What is Full Employment?

At its core, full employment describes a situation where all willing and able individuals in the labor force are employed. However, it does not imply zero unemployment. Instead, full employment acknowledges the presence of frictional and structural unemployment—reflecting the natural job turnover and the mismatch between workers' skills and job requirements, respectively—while aiming to eliminate cyclical unemployment, which arises from economic downturns.

Measuring Full Employment

Economists use various indicators to gauge full employment, with the unemployment rate being the most direct measure. However, defining a specific unemployment rate as indicative of full employment is challenging due to the dynamic nature of economies. This rate, often aligned with the concept of the Natural Rate of Unemployment (NAIRU), varies across time and economies, influenced by factors such as demographic trends, labor market policies, and technological advancements.

The Evolving Perspective of Full Employment

The 1980s Perspective

In the 1980s, the consensus among economists was that a higher unemployment rate, around 6% or more, was necessary to prevent inflation from spiraling. This belief was rooted in the experiences of the 1970s, when many economies struggled with stagflation—a combination of stagnant growth and high inflation.

The Phillips Curve, illustrating an inverse relationship between unemployment and inflation, supported this view, suggesting that reducing unemployment below a certain threshold would lead to unacceptable levels of inflation.

Today's Understanding

Fast forward to the present, and the landscape has dramatically shifted. Economies have achieved unemployment rates far below the 6% benchmark without triggering the anticipated inflationary pressures. This change is attributed to several key developments:

  • Inflation Targeting: Central banks have become more adept at managing inflation expectations, stabilizing the economic environment.
  • Labor Market Flexibility: The rise of the gig economy and deregulation efforts have introduced more flexibility into the labor market.
  • Globalization: The global integration of markets has exerted downward pressure on domestic inflation (in the US).
  • Technological Progress: Advances in technology have reshaped labor demand, potentially lowering the natural rate of unemployment.

These shifts have led to a reevaluation of the Phillips Curve and the NAIRU, with many economists now considering lower unemployment rates as being compatible with full employment.

Implications for Policy and the Economy

The evolving understanding of full employment has significant implications for economic policy and labor market strategies.

Policymakers, recognizing the more dynamic relationship between unemployment and inflation, have more leeway to pursue growth-oriented policies without the immediate fear of stoking inflation.

Additionally, the focus shifts towards ensuring that employment is not just about quantity but also quality, with an emphasis on creating jobs that are fulfilling, well-paid, and secure.

Conclusion

The concept of full employment remains a vital indicator of economic health and a key objective for policymakers. However, its definition and the means to achieve it have evolved, reflecting changes in economic understanding, policy effectiveness, and the global economic environment.

As we continue to navigate the complexities of modern economies, the pursuit of full employment will undoubtedly adapt to new challenges and opportunities, emphasizing the need for flexible, innovative approaches to economic policy and labor market participation.

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