Unemployment and Government Policy

When governments intervene to reduce unemployment, the appropriate policy depends on identifying correctly the underlying cause of unemployment. For example, if unemployment is incorrectly diagnosed in terms of demand deficiency, when the true cause is structural, a policy of fiscal or monetary expansion to stimulate aggregate demand will be ineffective and inappropriate. Indeed, reflation of demand in such circumstances would probably create excess demand, which raises the price level in a demand-pull inflation, with no lasting beneficial effects on employment.

Governments can try to reduce frictional unemployment by improving the geographical and occupational mobility of labour, and by reducing workers' search periods between jobs. Geographical mobility can be improved by making it easier for families to move house from one region to another. However, the widening difference in house prices between south and north are in fact increasing the geographical immobility of labour.

The introduction of the Job-seeker's Allowance in 1996 was an attempt to reduce search periods between jobs. Because the Allowance can only be claimed for the first few months of unemployment, it creates an incentive for the newly-unemployed to accept lower wage rates and to speed…