How Inflation Relates to Unemployment Levels

(An abstract of my take on an Economist article reviewing recent research findings - 2/1/14 p.66)

Economists have been surprised by how low the unemployment rate is in the US and Britain a few years down the road from the financial collapse.   And even though both Britain and the US now have relatively low unemployment rates, they seem to be driven by totally different circumstances.  

Britain's economy has been pretty stagnant since the economic downturn, but they didn't lose many jobs and in fact now have more people working that before the downturn, but productivity per worker has been falling. 

In the US growth has been stronger, but most of the drop in unemployment relates to people leaving the work force, not the creation of new jobs, and productivity per worker has continued to rise.  There are actually fewer people employed in the US that before the recession began, but productivity is up.

New research suggests the key is that inflation in Britain is about 3.1% while inflation in the US is 1.8%.  In Britain, even though workers have had modest wage increase, Britain wages have, in real terms, fallen by 7.8% since the crash, while the price of the goods and services companies provide has gone up, so employers can afford to increase production and hire people.  

In the US, since inflation has been much lower, real wages have fallen far less, US workers have actually seen a 2% overall rise in wages since the crash, so workers are still relatively expensive compared to what companies can get for their goods and services.

The related economic concept is called "sticky wages" - the notion workers are very resistant to taking a pay cut directly, but are somewhat oblivious to loss of purchasing power through inflation.  So in a recession with mild inflation employers find it hard to get people to accept wage cuts, so must push their workers to be more productive.  The increased productivity per worker means the employer doesn't need to hire more people.

A related concept noted in the article is the possibility the big losses banks absorbed in the financial collapse made banks more inclined to require tangible assets that will act as security before they will make a loan.  So companies who rely on lots of machinery are better placed to be successful to get financing, and thus can expand and drive growth in the post recovery, but companies who rely more on workers and less on machines can't get financing necessary to hire more people to expand production.