PRINCIPLE 10: SOCIETY FACES A SHORT RUN TRADE OFF BETWEEN INFLATION AND UNEMPLOYMENT

Although a higher level of prices is, in the long run, the primary effect of increasing the quantity of money, the short-run story is more complex and more controversial, Most economists describe the shortrun effects of monetary injections as follows:

• Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services
• Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to increase the quantity of goods and services they produce and to hire more workers to produce those goods and services.
• More hiring means lower unemployment.

This line of reasoning leads to one final economywide trade-off: a short-run trade-off between inflation and unemployment.

Although some economists still question these ideas, most accept that society faces a short run trade off between inflation and unemployment. This simply means that, over a period of a year or two, many economic policies push inflation and unemployment In opposite directions. Policymakers face this trade , off regardless of whether inflation and unemployment both start out at high levels (as they were in the early 1980s), at low levels (as they were in the late 1990s), or someplace in between. This short run tradeoff plays a key role in the analysis of the business cycle the irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.

Policymakers can exploit the short run trade off between inflation and unemployment using various policy instruments. By changing the amount that the government spends, the amount it taxes, and the amount of money it prints, policymakers can influence the combination of inflation and unemployment that the economy experiences. Because these instruments of economic policy are potentially so powerful, how policymakers should use these instruments to control the economy, if at all, is a subject of continuing debate.