why does low unemployment cause inflation?
In: 6
More people working = more people buying.
More people buying = less supply for the growing demand
More demand than supply = prices increase
Low unemployment itself doesn’t ’cause’ inflation, but its an indicator that would coincide with inflation.
Low unemployment generally means the economy is growing and booming along, and its when the economy is growing quickly and interest rates are low that you’re likely to have a lot more borrowing and creation of money supply.
And it’s that which leads to inflation.
So it’s not a cause so much as it is often correlated.
When people are unemployed they generally do not have a tremendous amount of money. When people get money they can compete for goods and services–this increases demand. If supply does not increase then prices will increase.
It doesn’t directly cause inflation. There have been periods with low unemployment and normal inflation levels. It can be one of the contributing factors to inflation though
All the replies so far have only mentioned that more people working means more money in the economy, pushing up prices
There is also the labour market side of this. In theory, when there are fewer unemployed people, wages go up because employees have more ‘power’ to negotiate higher wages. If companies have to pay higher wages, then they pass those costs on to the consumer through higher prices.
More people having jobs means that more people have money to spend, wich in turn means that money is worth less.
I think it is roughly this:
* Low unemployment means that if a firm/business wants to hire, it is harder to find an employee.
* They might increase the wage/salary to try and entice someone.
* This can lead to increases in wages (this is a type of inflation, the price of labor going up)
* Increases in wages mean more people with normal/average-ish income to have more spending money.
* This encourages business to charge slightly higher for their goods and/or services (another type of inflation)
* This has the potential to end up in a bit of a feedback loop, where now that things are more expensive, workers might only work for higher wages, and the cycle could repeat.
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To help imagine how this works, try to consider the extreme alternative.
Imagine that almost everyone gets fired tomorrow (for some reason), and unemployment skyrockets instantly.
Well, now everyone will be scared to spend money, because they don’t know when they’ll get more. Only the cheapest items will be bought, encouraging businesses that make cheap items to pump out more and more, but they’d struggle to raise prices since people could buy one of the cheaper alternatives instead.
People who sell expensive items will have to derease their prices to have a chance of selling their products.
People will also be willing to take a lower paying job just to make sure they have some form of income.
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(Now, unemployment is far from only factor to inflation. However it can factor in, and I’ve tried to detail how that could happen.)
As a basic cause and effect, low unemployment causes employers to increase their remuneration packages (higher wages on offer for open positions) to compete in a smaller pool of available employees. The employer now has an increased cost base, which they pass onto their customers. Their customers cost of living increases which means they seek an increase in pay. This is not just limited to hiring for new employees, but existing employees become aware of pay differentials within the same company or other companies in their industry and seek higher wages. Which begins the cycle.
Basically, the Federal Reserve has control of the money supply through two options:
* They increase the amount of money a bank has to have in proportion to the amount people deposit into it. If the bank has to keep $0.30 of every dollar deposited in reserve they have less money to lend than if they only have to keep $0.20 for every dollar deposited.
* They increase the cost of giving money to banks to lend money. Lower interest means they need to lend more to make the money back. Higher interest means they can’t afford to make riskier loans.
Low unemployment doesn’t cause inflation. People don’t buy more food or basic goods than they need just because they have more work; you can only consume so many eggs in a day or store so many in your fridge. It is not the fact that more people have income that drives up the price of eggs on its own.
What the Fed does is put the breaks on an expanding economy by restricting access to the money banks have, which means banks have less to lend and they charge higher interest rates. When interest rates are lower companies feel more confident in taking on projects because they cost less to fund. The opposite is true as well; high interest rates mean companies have to have high confidence in a highly profitable project before they will borrow.
The Fed does the opposite when there is high unemployment: they allow banks to have lower reserves and to lend at lower interest rates through easier access to cash. This makes companies more likely to take on projects that will make them hire people and get the economy back to the point where the Fed will restrict the money supply to slow the economy.
You can think of it like someone jerkily smashing the gas and the brakes on a car to try to achieve the posted speed limit on a highway. Given the limited tools they have they can’t just go on cruise control, they can only hit the breaks or the gas as hard as they can.
The basic macroeconomic answer is this:
If there is unemployment of people and resources, spending money can directly hire works and access those resources. This adds more incomes to buy the existing stuff, but also adds more work so it adds more stuff. Prices stay the same.
Once “everyone” has a job and the available resources are being used, then any extra money anyone spends is just going to bid prices (like an auction) higher, so the entity with extra money gets the scarce resource and those who offered less do not.
The real world is imperfect, money starts bidding up prices before literally all the people have jobs.
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Sometimes something happens that messes up how much resources we have, like people stop working for a year because of a lockdown or we lose lots of trade because of another country’s lockdowns. Then we have less stuff to buy but the same amount of money. That money can no longer buy the same amount of stuff, so it’s extra money and it drives up prices. In this event, the prices will continue to rise until the stuff shortage gets fixed.
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