Textbooks in economics link growth with employment, which sounds logical. Keynesian theory says that as a government spends money to alleviate unemployment, incomes would rise, leading to consumption and then investment, which through the multiplier effect would raise economic growth. Higher growth, thus, goes along with high employment. As an extension, the Phillips Curve showed that as employment rose beyond a point, inflation would result. The Friedman-Phelps theory argued that something called the ‘natural rate of unemployment’ exists and cannot be escaped in the long run. As central banks expand money supply to spur growth, it would lead to inflation while growth will increase marginally. Wages would increase in response, with job cuts and unemployment to follow. So monetary policy can’t always foster growth and employment together.
The Rational Expectations School made famous by Robert Lucas and Thomas Sargent had a different take, which said that policies cannot spur growth or employment. If information was symmetric and accessible to all agents, then everyone would respond rationally based on that data. Hence action would be predictable and there would be no real impact. As a corollary, the only way authorities could make an impact was to throw in surprises. But it would be temporary, so unemployment would be in equilibrium most of the time and would be similar to the ‘natural rate’.
This assumes relevance amid global talk of a recession, a situation of weak or negative growth with massive job losses. However, conventional theory has been turned upside down by developments in the world economy.
