Unemployment as a Result of Cost-Push Inflation: Impacts On The Economy

The term ‘economy’ is defined as the wealth and resources of a country or region, especially the terms of the production and consumption of goods and services. Many factors play a role in economic growth, but two of the most influential are inflation and high unemployment rates. Cost-push inflation occurs when there is a decline in the supply of goods and services, but the demand remains unchanged. A paper published by Micheal Wachter, a professor of law, management, and economics at the University of Pennsylvania, stated “...of specific concern is the period from 1969 to 1971 when an unemployment rate which climbed to 6 percent was accompanied by a continuing high rate of wage and price change,” (Wachter, 1974). The growth of unemployment was accompanied by a growth in prices or cost-push inflation. This effect on unemployment can lead to negative economic impacts on both a larger and smaller scale. Not only does it affect the economy as a whole, but it also has a severe impact on each and every individual within the economy.  According to a report written by Linda Levine, a specialist in labor economics, “The persistently high unemployment rate is a cause of concern to Congress for a variety of reasons. Among them is the high rate’s deleterious impact on individuals’ economic well-being…”(Levine, 2013). There is a clear connection between unemployment and a dangerously negative impact on the economy. The inflation of prices due to cost-push inflation negatively impacts the employment status, which can cause decreased consumer demand, business closures, and overall negative economic effects. 

Unemployment’s Effect on Consumer Demand

As unemployment increases as a result of cost-push inflation, consumer demand begins to drop. Consumer demand is the willingness of consumers to purchase certain goods or services. Their willingness can be affected by many factors such as price, disposable income, quantity, and many more. A paper published by Yale University states, “Unemployment causes a large but short-lived drop in income, generating a need for liquidity,” (Ganong, 2015). When an individual is unemployed for an ongoing period of time, their disposable income is extremely limited, causing their demand for products to decrease. Spending drops significantly directly after unemployment, but takes an even sharper drop after the individual’s benefits wear off. According to Yale’s paper on unemployment and consumer spending, spending drops 6% at the onset of employment and doubles to 12% as benefits are exhausted. An article published in the National Library of Medicine states, “In the 14th five-year plan of the PRC (2021–2025), consumer demand is considered as the basis for future economic development and GDP per capita growth,” (Asanov, 2021). As demand for products and services decreases, it leaves little room for economic growth. Demand creates interest in new products and industries, something that leads to capital accumulation and is therefore vital to economic growth.  Increasing unemployment rates as a result of cost push inflation leads to a lack of consumer demand due to minimal income in households. This lack of consumer demand leaves a largely negative impact on the economy.

The Effect of Unemployment on Businesses

Another aspect of the economy that is affected by high unemployment rates due to cost-push inflation is businesses. High unemployment rates can cause new businesses not to develop and pre-existing businesses to close down. A paper written on the effects of unemployment on new firm formation by Jari Ritsila, a professor with a Ph.D. in economics, and Hannu Tervo, a professor of economics, states “Third, a high level of overall unemployment (business cycle effect) can be assumed to decrease new firm formation,” (Ritsila, 2002). While unemployment rates are high, both internal and external demand for goods and services is low. The risk of creating new businesses far outweighs the reward, causing business development to halt. Additionally, unemployment causes pre-existing businesses to shut down. A paper written by David Storey, an author and professor of enterprise, states, “Furthermore, as Binks and Jennings (1986) point out, unemployment in an economy is likely to coincide with the closure of businesses…” (Storey, 1991). The closure of businesses is directly linked to cost-push inflation. As prices rise, businesses often end up having to lay off employees. The lack of workers combined with the high prices is detrimental to a business’s success and will eventually result in its closure. The rising unemployment rates due to cost-push inflation are extremely damaging to businesses and can lead to a lack of developing businesses as well as the ultimate closure of existing businesses.

Unemployment’s Negative Impact on the Economy

The several negative impacts of unemployment as a result of cost-push inflation build up to cause an overall decrease in economic growth. A paper published in the European Journal of Marketing and Economics that was written by Diellza Kukaj states “...the model suggests that an increase by one percentage point of unemployment will reduce GDP-growth by 0.5 percent points.” The GDP is often used as an indicator of economic health. The lower the GDP, the weaker the economy. Research has shown that high unemployment has a direct relationship with a decreasing GDP, displaying how a high unemployment rate, which can be caused by cost-push inflation, is damaging to the economy. Not only does unemployment have a large-scale negative impact on the economy, as seen through the GDP, but it also has a much more personal impact on individuals’ and families’ economic health. Sara Strom, with the Swedish Institute for Social Research, wrote a paper on unemployment and its effect on families that states, “ It is generally found that unemployment is correlated with such things as the propensity for divorce or the well-being of the spouse and children.” The effects of unemployment go further than simply affecting the unemployed individual, but can completely change both their life and their family’s. Some of these effects include poverty, strained relationships, inability to afford necessities, and many more. The influence of unemployment as a result of cost push inflation has a severely harmful effect on the overall health of the economy. 

Counter Argument

Cost push inflation is also known as wage push inflation. Wage push inflation occurs when employers have to increase their wages in order for their workers to keep up with price inflation in the economy. Some argue that wage push inflation increases employment due to the attraction employees have towards it. Justin Shweitzer, a senior research analyst, and Kyle Ross, a policy analyst for inclusive economy, wrote a paper published by the Center for American Progress stating, “Many businesses have found attracting workers much easier after improving conditions and increasing wages,” (Shweitzer, 2021). However, this increase in employment only exists in the short term. It becomes clear to workers that these new wages are not much of a change due to the inflationary environment around them. This causes them to be less willing to supply labor, causing the unemployment rate to continue rising as a result of wage push inflation, also known as cost push inflation.

Conclusion

The negative effects of cost push inflation are very prevalent, and action should be taken to control it. Economists have proposed many solutions, but the most promising of them all is increasing interest rates. Tejvan Pettinger, an economics professor at Oxford University, wrote an article on the many suggested policies to reduce cost push inflation that states “Higher interest rates increase the cost of borrowing and discourage consumer spending and investment,” (Pettinger, 2022). These higher rates will also cause appreciation in the exchange rate and lowered prices on imported goods. Not only will this reduce cost push inflation, but it will also lead to economic activity that ultimately results in economic growth. Pettinger also provides another perspective of why this solution has the possibility of being unsuccessful. Higher interest rates have the risk of leading to a larger problem of recession. Even if they are successful, it would take a considerable amount of time for this to occur. The inflation of prices due to cost push inflation leads to a highered unemployment rate which decreases consumer demand, leads to negative effects on businesses, reduces expansion, and ultimately, limits economic prosperity. The mere presence of inflation is detrimental to the economy as we know it. 

References

Asanov, B. (2021, November 5). Activating Consumer Demand as a Key to Successful Development of the PRC Economy. National Library of Medicine. Retrieved January 31, 2024, from https://www.ncbi.nlm.nih.gov/pmc/articles/PMC8569506/

Ganong, P., & Noel, P. (2015, November 4). How Does Unemployment Affect Consumer Spending? Yale Department of Economics. https://economics.yale.edu/sites/default/files/jmp_0.pdf

Kukaj, D. (2018). Impact of Unemployment on Economic Growth: Evidence from Western Balkans. European Journal of Marketing and Economics, 1(1).

Levine, L. (2013, January 7). Economic Growth and the Unemployment Rate. Congressional Research Service. https://sgp.fas.org/crs/misc/R42063.pdf

Pettinger, T. (2022, April 6). Policies to reduce cost-push inflation. Retrieved January 31, 2024, from https://www.economicshelp.org/blog/168312/economics/policies-to-reduce-cost-push-inflation/

Ritsilä, J., & Tervo, H. (2002). Effects of unemployment on new firm formation: Micro-Level panel data evidence from finland. Small Business Economics, 19(1), 31-40.

Schweitzer, J., & Ross, K. (2021, November 3). Higher Minimum Wages Support Job Growth as the Economy Recovers From COVID-19. Center For American Progress. https://www.americanprogress.org/wp-content/uploads/sites/2/2021/11/Higher-Min-Wages-Support-Job-Growth.pdf

Storey, D. J. (1991). The birth of new firms: Does unemployment matter? A review of the evidence. Small Business Economics, 3(3), 167-178.

Ström, S. (2003). Unemployment and families: A review of research. Social Service Review, 77(3), 399-430. https://doi.org/10.1086/375791

Wachter, M. L. (1974). Phase II, Cost-Push Inflation, and Relative Wages. The American Economic Review, 64(3), 482-491. JSTOR. http://www.jstor.org/stable/1808905