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Economic Fluctuations, Unemployment, and Inflation

GWARTNEY – STROUP – SOBEL – MACPHERSON

To Accompany: “Economics: Private and Public Choice, 15th ed.”

James Gwartney, Richard Stroup, Russell Sobel, & David Macpherson

Slides authored and animated by: James Gwartney & Charles Skipton

Full Length Text —

Macro Only Text —

Part: 3

Chapter: 8

First page

Swings in the Economic Pendulum

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Instability in the Growth of Real GDP: 1960-2013

Although real GDP in the United States has grown at an average rate of approximately 3%, the growth has been characterized by economic ups-and-downs. Note: periods of recession are indicated with shading.

Annual Rate of Growth in Real GDP (long-run growth rate approximately 3%)

Source: Economic Report of the President, various issues.

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2013

-4%

-2%

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The Hypothetical Business Cycle

The four phases of the hypothetical business cycle are expansion, peak, contraction, and recessionary trough.

In contrast with the business cycle represented here, as the previous exhibit illustrated, real world business cycles are characterized by expansions and contractions of varying duration and magnitude.

Time

Real GDP

Business

peak

Recessionary

trough

Contraction

Expansion

Business

peak

Recessionary

trough

Trend line

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Economic Fluctuations and the Labor Market

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Labor Market Classifications

Employed – a person (16 years old or over) who is:

working for pay at least one hour per week,

self employed, or,

working 15 hours or more each week without pay in a family-operated enterprise.

Unemployed – a person not currently employed who is:

actively seeking a job, or,

waiting to begin a job, or,

on layoff, waiting to return to a previous job.

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Labor Market Classifications

Civilian Labor force – civilians (16 years & older) who are:

either employed or unemployed.

Not in the labor force – persons (16 years & older) who are:

neither employed nor unemployed (like retirees, students, homemakers, or disabled persons).

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Labor Market Indicators

The non-institutional civilian adult population is grouped into two broad categories:

Persons not in the labor force, and,

persons in the labor force (this group includes both the employed and unemployed).

Employed + Unemployed

Recall the Labor Force =

Labor Force Participation Rate

# in the Labor Force

Civilian population (16+)

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U.S. Population, Employment, and Unemployment: April 2013

Civilian population

16 and over

Civilian

labor force

Employed

Employees

Self-employed

workers

Unemployed

New entrants

Reentrants

Lost last job

Quit last job

Laid off

Not in the

labor force

Household workers

Students

Retirees

Disabled

Labor Force Participation Rate

Civilian labor force

Civilian population (16+)

63.3%

Employment / Population Ratio

Number employed

Civilian population (16+)

58.6%

Rate of Unemployment

Number unemployed

Civilian labor force

7.5%

155.2 million

143.6 million

89.9 million

245.2 million

11.7 million

155.2

245.2

143.6

245.2

11.7

155.2

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Labor Force Participation Rate of Men and Women, 1948-2012

The labor force participation rate of women has been steadily increasing for several decades.

During the same period the rate of men has been falling.

Labor Force Participation Rate

of Men and Women

Source: www.bls.gov.

2012

1975

1948

1960

83%

70 %

33 %

38 %

46 %

57.5 %

––––––– Men –––––––

–––––– Women ––––––

1990

2012

1975

1948

1960

1990

78 %

76 %

57.7 %

87 %

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Labor Force Participation Rate and Employment-Population Ratio: 1980-2013

Both the labor force participation rate and the employment-population ratio trended upward from 1980-2000, but have been declining since.

Both figures fell sharply during the 2008-2009 recession. Each has had a weak rebound during the recovery phase of this business cycle. In 2013, both were still below their 2007 levels.

Sources: Willem Van Zandweghe, “Interpreting the Recent Decline in Labor Force Participation,” Federal Reserve Bank of Kansas Economic Review (Quarter 1, 2012): 5-34; and Daniel Aaronson, Jonathan Davis, and Loujia Hu, “Explaining the Decline in the U.S. Labor Force Participation Rate,”

Chicago Fed Letter, no. 296, (March 2012):1-4.

1980

1985

1990

1995

2000

2005

2013

56 %

58 %

60 %

62 %

64 %

66 %

68 %

2010

Employment-Population Ratio

Labor Force Participation Rate

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Composition of the Unemployed by Reason in 2013 (April)

There are various reasons why persons were unemployed in April of 2013.

Nearly one-half (44.8%) of the unemployed were dismissed from their previous jobs.

More than a third (37.8%) of the unemployed were either new entrants or reentrants into the labor force.

Job leavers

7.4%

10.9%

26.9%

10%

44.8%

New entrants

Reentrants

On Layoff

Dismissed from Previous Job

Breakdown of Unemployed 2013 (April)

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10.9 26.9 10 44.8 7.4

The Unemployment Rate By Age and Gender: April 2013

In 2013, the unemployment rate for men was 7.7%, compared to only 7.3% for women.

The observed differential between male and female workers was higher with younger workers.

The unemployment rate itself was also much higher for those under the age of 25 than for those over the age of 25.

Source: www.bls.gov.

Both

25+

16-19

20-24

–– Men aged ––

All men

All women

–– Women aged ––

25+

16-19

20-24

7.5%

26.2%

22.1%

14.0%

6.3%

7.7%

7.3%

12.3%

5.9%

Civilian Rates of Unemployment (April 2013)

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Questions for Thought:

1. Classify the following as employed, unemployed, or not in labor force:

a) person who is not working but applied for a job at Target last week

b) person working part-time and searching diligently for a full-time job

c) auto worker vacationing in Florida during a layoff at a General Motors plant who expects to be recalled in a couple of weeks

d) 17-year-old who works 6 hours per week as a throwing newspapers

e) homemaker working 70 hours a week preparing meals and performing other household services

f) college student who spends between 50 and 60 hours per week attending classes and studying

g) a retired Social Security recipient

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Questions for Thought:

2. The following are for the U.S. in 2011 (in millions)

Population 311.3

Civilian pop. (age 16 and over) 239.1

Employed 139.7

Unemployed 13.7

a) Calculate the unemployment rate

b) Calculate the labor force participation rate

c) Calculate the employment / population ratio

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Three Types of Unemployment

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Frictional Unemployment:

Caused by imperfect information.

Occurs because:

employers are not aware of all available workers and their qualifications, and,

available workers are not fully aware of all the jobs being offered by employers.

Three Types of Unemployment

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Structural Unemployment:

Reflects an imperfect match of employee skills to skill requirements of the available jobs.

Also reflects structural and demographic characteristics of the labor market.

Cyclical Unemployment:

Reflects business cycle conditions

When there is a general downturn in business activity, cyclical unemployment increases.

Three Types of Unemployment

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Employment Fluctuations: The Historical Record

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Unemployment and Output Are Linked Over the Business Cycle

The unemployment rate from 1960-2013 is illustrated here.

As expected, unemployment rose rapidly during each of the eight recessions (the shaded years indicate periods of recession).

In contrast, after each recession ended, the unemployment rate began to decline as the economy moved into an expansionary phase of the business cycle.

Note that the actual rate of unemployment was greater than the natural rate during and immediately following each recession.

Sources : http://www.bls.gov/ and, Robert J. Gordon, Macroeconomics (Boston: Addison-Wesley, 2012).

Unemployment Rate (U.S) 1960 - 2013

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2013

10%

12%

of unemployment

Actual rate

of unemployment

Natural rate

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Full Employment: Level of employment resulting when the rate of unemployment is normal, considering both frictional and structural factors.

Full employment is closely related to the concept of the natural rate of unemployment.

Natural Rate of Unemployment: Level of unemployment that reflects “job shopping” in an economy of imperfect information and dynamic change.

The Concept of Full Employment

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The natural rate of unemployment is:

neither a temporary high nor temporary low.

a rate that is both achievable and sustainable.

the level of unemployment accompanying an economy’s “maximum sustainable rate of output.”

Both demographic factors (e.g. young workers as a share of the labor force) and public policy (e.g. the level of unemployment benefits) influence the natural rate of unemployment.

Actual rate of unemployment generally rises above natural rate during a recession and falls below the natural rate during a boom.

The Concept of the Natural Rate of Employment

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Actual and Potential GDP

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Potential output: Maximum sustainable output level consistent with the economy’s resource base, given its institutional arrangements.

Actual and potential output will be equal when the economy is at full employment.

Actual and Potential GDP

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1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2013

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1970 recession

1974-75 recession

1980 recession

1982 recession

1990-91 recession

2001 recession

1960 recession

2008-10 recession

Potential GDP

16,000

Actual and Potential GDP, 1960-2013

Here we illustrate both actual GDP & potential GDP.

Note the gap between actual and potential GDP during periods of recession.

Real GDP (billions of 2005 $)

Source: http://www.bls.gov

Actual GDP

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Questions for Thought:

1. During a recession, which of the following will be true?

a. Actual rate of unemployment will be lower than the natural rate.

b. Actual GDP will be lower than potential GDP.

c. Actual employment will exceed what is considered as full employment.

2. How will increased usage of the Internet by employers and employees influence the job search process? Will it tend to increase or decrease the natural rate of unemployment?

3. (True or false) When full employment is present the rate of unemployment will be zero.

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Questions for Thought:

4. What is the relationship between full employment and the natural rate of unemployment? Why might the natural rate change?

5. Frictional unemployment is a result of:

(a) not enough jobs for everyone to be employed

(b) unemployed workers’ skills not matching those needed for available jobs

(d) imperfect information & temporary periods of unemployment while workers change jobs

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The Effects of Inflation

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Inflation

Inflation is a change in the general level of prices as measured by a price index such as the GDP deflator or the consumer price index.

Inflation is generally measured at an annual rate.

When inflation is high, the year-to-year changes in the inflation rate are nearly always highly variable, making them difficult to predict.

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The Inflation Rate, 1956-2013

Between 1956 and 1965, the general price level increased at an average annual rate of only 1.6%.

In contrast, the inflation rate averaged 9.2% from 1973 to 1981, reaching double-digits during several years.

Since 1982, the average rate of inflation has been lower (2.9% from 1983-2013) and more stable.

1956

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

-5%

10%

15%

1983-2013 average inflation rate = 2.9 %

1956-1965 average inflation rate = 1.6 %

1973-1981 average inflation rate = 9.2 %

2013

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Inflation Rates Across Economies: 2006-2012

The rate of inflation varies widely among countries.

For Canada, Germany, Switzerland, and the U.S. the annual inflation rates for the 2006-12 period were below 4% -and- variations (year to year) were no more than 1 or 2%.

In contrast, both the annual inflation rate and the change between years was much greater for Bolivia, Iceland, Russia, and Venezuela.

High rates of inflation are almost always associated with substantial year-to-year swings in the inflation rate.

Annual Inflation Rates

Source: International Monetary Fund; http://www.IMF.org

2006

2007

2008

2009

2010

2011

2012

Germany

Switzerland

United States

Canada

Low Inflation (%)

2.0

2.1

2.4

0.3

1.8

2.9

1.5

1.8

2.3

2.6

0.3

1.1

2.1

2.0

1.1

0.7

2.4

-0.5

0.7

0.2

-0.7

3.2

2.9

3.8

-0.4

1.6

3.2

2.1

Bolivia

Russia

Iceland

Venezuela

High Inflation (%)

6.6

4.8

7.8

5.6

6.1

5.8

3.3

6.7

5.1

12.7

12.0

5.4

4.0

5.2

9.7

9.0

14.1

11.7

6.9

8.4

5.0

13.7

18.7

31.4

28.6

29.1

27.2

21.1

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Unanticipated and Anticipated Inflation

There are two different kinds of inflation:

Unanticipated inflation: An increase in the price level that comes as a surprise, at least for most individuals.

Anticipated inflation: A widely expected change in the price level.

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Effects of Inflation

High and variable rates of inflation are harmful for several reasons:

Because unanticipated inflation alters the outcomes of long-term projects like the purchase of a machine or operation of a business, it will both increase the risks and retard the level of such productive activities.

Inflation distorts the information delivered by prices.

People will respond to high and variable rates of inflation by spending less time producing and more time trying to protect their wealth and income from the uncertainty created by inflation.

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Nearly all economists believe that rapid expansion in the money supply is the primary cause of inflation.

What Causes Inflation?

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Questions for Thought:

Suppose that the CPI was 150 at the end of last year and 157.5 at the end of this year. What was the inflation rate during the year?

If decision makers anticipate an inflation rate of 3% at the start of a year and prices rise by 7% during the year, this is an example of

a. anticipated inflation.

b. an inflation rate higher than the anticipated.

c. an inflation rate lower than the anticipated.

3. (True or false) When the inflation rate is high and variable, decision makers will generally be able to anticipate year-to-year changes in inflation quite accurately.

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Questions for Thought:

4. How would an unanticipated jump in inflation impact the wealth of:

a. Joe, who has a 30-yr home mortgage at a fixed interest rate

b. The McCoy's, who hold most of their wealth in long-term fixed yield bonds

c. Hanna, a retiree drawing a pension of a fixed dollar amount

d. Jose, a heavily indebted small-business owner.

e. Mike, the owner of an apartment complex with substantial debt at a fixed interest rate

f. Tina, a worker whose wages are determined by a 3-year union contract ratified three months ago

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Questions for Thought:

5. What impact will high and variable rates of inflation have on the economy? How will they influence the risk accompanying long-term contracts and related business decisions?

6. Compared to the United States, labor markets in France, Italy, and Spain are characterized by more generous unemployment benefits. Other things constant, how will this influence the unemployment rate in in these countries compared to that in the U.S.? Explain. Check your answers to see if your response is correct..

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End of

Chapter 8

First page