Public Policy Implications of Behavioral Economics and Happiness Studies

Abstract

More than 10 years ago, I was in a session of the American Economic Association Annual Meetings. The speaker made some remark to the effect that it is desirable to have a small positive rate of inflation around 2 to 5%. In a growing and changing economy, resources including labor have to be reallocated from shrinking to expanding industries. It is necessary to have the real wage rates in declining industries to decline by a few percents a year to motivate people to transfer to the expanding industries. With a positive rate of inflation, this could be achieved without having to resort to the lowering of the nominal wage rates which is more painful and is resisted more by the relevant workers. participant commented that this is impossible as the same consumption possibility set is entailed by reducing the real wages by the same x% either by lowering the nominal wage rates with no inflation or by keeping the nominal wage rates but with some positive inflation.