Contractionary Monetary Policy, Female Labor Supply, and the Unemployment-Inflation Tradeoff

Contractionary Monetary Policy, Female Labor Supply
 and the Unemployment-Inflation Rate Tradeoff

Authors:  Thomas D. Birch, Professor of Economics, University of New Hampshire at Manchester and Sara Dustin, Independent Study Student, University of New Hampshire at Manchester

This paper analyzes the social and distributional impact of endogenous changes in labor force participation by females in response to contractionary monetary policy.  The paper focuses on the Federal Reserve’s 1979 anti-inflationary policy and Congressional testimony of Paul Volcker to identify several factors overlooked when evaluating the costs of a contractionary monetary policy that nevertheless deserve attention in policy debates regarding the nature of the unemployment-inflation tradeoff:

1) The distortion in the household’s labor-leisure/child rearing choice due to a change in the real wage rate triggered by monetary tightening.  There is evidence of a strong association between an increase in unemployment and a fall in wages in the same or next year since 1970.  Using a standard microeconomic household choice theoretic framework of the Becker type, we demonstrate there is a welfare loss to the household due to a reduction in the relative price of labor associated with the rising unemployment rates generated by contractionary monetary policy, irrespective of whether the female chooses to work more or less;

2) If the response to a lower real wage rate is increased labor force participation of married women due to the loss of husband’s income (for a discussion of this influence, see Juhn and Potter, 2006) then there is a potential decrease in the supply of parental nurture for families with children;

3)  Macroeconomic theory suggests that because females, on average, are paid less than males, an accelerated entry of wives into the labor force to bolster family income during periods of recession may help speed economic recovery by lowering average labor costs while maintaining household demand.  However, for households raising young children, the cost of child care necessary to release wives into the workforce tends to cancel out any nominal increases in wage income realized by two-job married-couple households.  Our analysis finds that this effect is most pronounced below the 70^th wage percentile and leaves couples working at or below the 30^th wage percentile with less real income left over to support their families than they realized in 1978; and

4)  Previous research shows that the fall of real wages below the 70^th percentile has contributed to a decrease in labor’s share of national income (Mishel, Bernstein, Allgretto, 2005).  Wives entry into the workforce in response to contractionary monetary policy accelerates this trend by lowering average wages more quickly.

We conclude that the unemployment increases consequent to anti-inflationary monetary policy have contributed to two significant long term adverse social/economic trends in the United States once female labor supply responses are taken into account: 1) a reduction in the availability of parental nurture to children and 2) a widening income gap.

JEL Code: [E00, E50, J21, J30]