BPEA | 1971 No. 3

Alternative Paths to a Stable Full Employment Economy

William Poole David I. Fand and John Kareken

1971, No. 3

How RAPIDLY SHOULD THE ECONOMY be pushed back to full employ- ment? With the great public concern about engineering a vigorous re- covery, the question of the optimum speed of the recovery has been largely ignored. There are two basic elements to the question. The first is the tradeoff between inflation and unemployment. The more rapid the recovery is, the higher will be the rate of inflation, both during the recovery phase and, as a result of lags in adjustment, during at least the early part of the subsequent full employllment phase. If it is assumed that wage-price controls cannot completely suppress inflation, the introduction of controls does not funda- mentally alter the problem, since a more rapid recovery will still produce more inflation than will a less rapid recovery. Given a utility function defining the gains from less unemployment and from less inflation, the problem can be viewed as one of choosing the “best” or “optimal” path from among all possible output paths over, say, the next ten years, where each output path entails a particular price path dependent on the structure of the economy.