Curiosity 11.1: What Is the Term Structure of Interest Rates?

		Consider now stagflation defined as rising inflation in conjunction with rising unemployment. There are several ways in which these things can happen at the same time:

		1. An increase in money growth. The dynamic reaction of the economy to an increase in the rate of money-supply growth is such that, in its later stages, inflation and unemployment increase together, as illustrated by the path from point C to D in figure 12.2.

		2. A supply shock. A negative supply shock raises costs, causing producers to raise prices. The higher prices lower aggregate demand, so output and employment fall.

		3. Labor hoarding. As an economy moves into recession and unemployment rises, firms tend to keep on some redundant employees (in order to keep trained labor available for the end of the recession). This policy raises per-unit costs, requiring higher markups to maintain profitability. The lower output level also implies a loss of economies of scale, also raising per-unit costs.

		4. Participation rate changes. A rise in inflation often occurs when employment is rising. It is possible that discouraged workers may rejoin the labor force if they see employment rising, and the measured level of unemployment rises as a result.

		5. Inflation variability. When inflation is higher, its rate is more variable, increasing uncertainty in economic markets. Firms react by investing less, thus decreasing economic growth.

		Media Illustrations

		Example 1

		Just as in the '30s when government intervened to save capitalism from itself, so again must it intervene massively now to save government capitalism from itself. Since government now protects individuals and corporations from the consequences of excessive wage and price increases, government must now prevent those excessive increases by permanent wage and price controls.

		How did government intervene in the '30s to save capitalism from itself?

		The Great Depression is viewed by the author of this clipping as a product of the capitalist system. The government intervened in the Depression by using fiscal policy to increase government spending.

		What are the consequences of excessive wage and price increases, and how does the government protect individuals and corporations from these consequences?

		Excessive wage and price increases, if not accommodated by money-supply increases, decrease sales and lead to unemployment. The government protection takes the form of monetary accommodation designed to maintain full employment.