Progressive Money

Economics in the Real World · scenario 5 of 10 · about 13 min

“Unemployment has to increase to control inflation.”

Why people make this argument

When the RBA raises interest rates, it usually forecasts unemployment rising too, and commentators say the labour market has to 'loosen'. The reasoning comes from the Phillips curve: when jobs are plentiful, employers bid for scarce workers, wages rise faster and firms pass on the cost. Cooling demand reduces that pressure, and some extra unemployment is how it shows up.

The strongest version does not say unemployment is good. It says that when inflation comes from demand outrunning capacity, there may be no painless way to slow it, and that letting high inflation persist would also hurt low-income households, and could cost more jobs later if it became entrenched.

Ideas you'll need

What isn't in dispute

Under the Reserve Bank Act and the Statement on the Conduct of Monetary Policy, the RBA's mandate covers both price stability, defined as 2 to 3 per cent inflation, and full employment. Its framework assumes a short-run trade-off: below the NAIRU, inflation tends to rise. The NAIRU cannot be observed; a 2017 RBA estimate of about 5 per cent came with a band of roughly 4 to 6 per cent, and in February 2024 the RBA's models put the unemployment rate consistent with full employment at about 4 to 5½ per cent.

Trimmed mean inflation fell from 6.9 per cent over 2022 to 3.2 per cent over 2024. Unemployment was 4.2 per cent in August 2025, which the Governor called low by historical standards, and 4.6 per cent in August 2026.

How mainstream economists would analyse it

The RBA argues that when demand outruns the economy's capacity, slowing demand is the reliable way to bring inflation down, and that this usually means somewhat higher unemployment for a time. It presents that as easing a tight labour market, not as a goal.

Mainstream economists debate how large the trade-off is. Hooper, Mishkin and Sufi found the Phillips curve looks flat in national US data but clearly present in state and city data, suggesting the link is real but hard to see. Many argue that anchored expectations let inflation fall at a smaller cost in jobs, which is one reading of Australia's experience after 2022, and most accept that inflation from supply shocks can fade without higher unemployment. So the mainstream claim is weaker than 'has to': demand-driven inflation is hard to reduce without some slack in the labour market.

How MMT economists would analyse it

MMT economists reject the idea that unemployed people should be the economy's inflation buffer. Bill Mitchell and Pavlina Tcherneva argue that NAIRU estimates are too unreliable to steer by, and that unemployment imposes large, lasting costs, including lost skills, on those least able to bear them. The post-Keynesian economist James Galbraith argued in 1997 that the NAIRU should be dropped altogether.

They propose a different buffer: a Job Guarantee offering work at a fixed wage to anyone who wants it. Because it never bids against private employers, they argue, it would expand in downturns, shrink in booms and anchor wages without leaving people jobless. They also stress that much of the 2021–23 inflation came from supply shocks and margins, which unemployment does little to fix. They accept that excess total spending causes inflation; they dispute that unemployment is the only way to restrain it.

Your turn

Your turn: Australia's inflation fell sharply after 2022 while unemployment stayed low by historical standards. Does this support or undermine the claim that unemployment has to rise to control inflation? Name the competing interpretations.

Show a model response and the rubric

It undermines the strong version of the claim, but does not show there is no trade-off. Trimmed mean inflation fell from 6.9 per cent over 2022 to 3.2 per cent over 2024 while unemployment stayed low by historical standards. That fits the view that much of the surge came from supply shocks that unwound, which unemployment could not have fixed.

A mainstream economist would point out that the RBA raised rates thirteen times and unemployment did drift up, reaching 4.6 per cent by August 2026. On that reading, a cooling labour market and anchored expectations let inflation fall at a small cost in jobs, but without the rate rises inflation might have stuck. An MMT economist would say the episode shows the NAIRU framework overstates the need for unemployment, and that a Job Guarantee could provide a buffer without joblessness.

My conclusion depends on how much of the inflation was supply-driven and what would have happened without rate rises, which no one can observe directly. Evidence that would change it: studies separating supply and demand drivers, wage and margin data, and whether inflation returns if unemployment falls again.

A strong response

  • Distinguishes demand-driven from supply-driven inflation and explains why it matters here
  • Explains the NAIRU accurately, including its uncertainty
  • States the RBA's reasoning fairly, without attributing to it views it does not hold
  • Describes the Job Guarantee as an alternative buffer, and as a proposal rather than a tested Australian policy
  • Uses dated Australian data accurately and names evidence that would decide the question

There is no single right answer. Reach your own conclusion, and be ready to say what evidence would change it.

Limitations and counterarguments

The MMT alternative is a proposal, not a tested remedy. No country has run a permanent national Job Guarantee at the scale proposed. Critics argue its wages would still be spent, adding to demand, and that a fixed-wage pool might not restrain inflation as reliably as unemployment. Programs with similar features, such as India's rural employment guarantee and Argentina's Plan Jefes, are informative but operate in very different economies.

The mainstream framework has limits too. The NAIRU's band is wide and its estimates have moved a lot, so policy based on it risks holding unemployment higher than needed. Neither side can observe what would have happened in 2022–24 without rate rises. And weighing a point of inflation against a point of unemployment is a value judgement.

Revisit How the RBA thinks about unemployment and inflation · Property developer says unemployment should rise · Professor Bill Mitchell - The Government Chooses the Unemployment Rate · MMT: What Is A Job Guarantee (or "Labor Standard")? · Professor Bill Mitchell - Inflation Targetting

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