Unemployment, Inflation, NAIRU

Unemployment Civilian labor force: worked 1 hour for pay in last week unless sick/vacation/strike Civilian labor force: worked 1 hour for pay in last week unless sick/vacation/strike Not military, not students, not retired, not discouraged workers Not military, not students, not retired, not discouraged workers # unemployed / civilian labor force x 100= unemployment rate # unemployed / civilian labor force x 100= unemployment rate

Types of Unemployment Frictional: looking for better job (good thing) Frictional: looking for better job (good thing) Seasonal: it’s raining Seasonal: it’s raining Structural: skills no longer useful Structural: skills no longer useful New tech, new resources, loss of old resources, changes in demand, globalization, lack of education New tech, new resources, loss of old resources, changes in demand, globalization, lack of education Cyclical: changes in biz cycle  unemployment Cyclical: changes in biz cycle  unemployment Underemployed: overqualified or part-time when want full-time Underemployed: overqualified or part-time when want full-time

Full/Natural Rate Unemployment Impossible (undesirable) 0% unemployment Impossible (undesirable) 0% unemployment Elimination of cyclical unemployment  full employment/natural rate Elimination of cyclical unemployment  full employment/natural rate  Potential output  Potential output

Economic Costs Unemployment Okun’s Law: every 1% actual U > natural rate  GDP gap (actual less than potential) of 2% Okun’s Law: every 1% actual U > natural rate  GDP gap (actual less than potential) of 2% Unequal burdens: occupation, age, race, gender, education, duration Unequal burdens: occupation, age, race, gender, education, duration Noneconomic costs: depression, political impacts Noneconomic costs: depression, political impacts

Inflation Rising price level (average) Rising price level (average) Consumer Price Index: “prices of a market basket of some 300 consumer goods and services purchased by a typical urban consumer” Consumer Price Index: “prices of a market basket of some 300 consumer goods and services purchased by a typical urban consumer” Hasn’t been updated in 30+ years; undercounts housing + medical Hasn’t been updated in 30+ years; undercounts housing + medical Producer Price Index Producer Price Index Reduces purchasing power Reduces purchasing power

Types Inflation Inflation Hyperinflation Hyperinflation Deflation Deflation Disinflation Disinflation

Causes 1) Demand-pull (AD up): “too much spending chasing too few goods” 1) Demand-pull (AD up): “too much spending chasing too few goods” Wage-price spiral Wage-price spiral 2) Cost-push (AS down): increase cost production 2) Cost-push (AS down): increase cost production Problem: which is it? DP indefinite, CP self-limiting (  recession  eventually costs back down  recovery) Problem: which is it? DP indefinite, CP self-limiting (  recession  eventually costs back down  recovery) 3) Quantity theory: too many dollar bills (more later) 3) Quantity theory: too many dollar bills (more later)

Redistribution Effects Anticipated inflation: less important  offset w/ interest rates or wage raise Anticipated inflation: less important  offset w/ interest rates or wage raise Unanticipated is problem Unanticipated is problem 1) Fixed-nominal-income receivers (fixed income) 1) Fixed-nominal-income receivers (fixed income) COLA: Cost Of Living Adjustment COLA: Cost Of Living Adjustment 2) Savers/holders of currency (inflation tax) 2) Savers/holders of currency (inflation tax) 3) Debtors vs. Creditors 3) Debtors vs. Creditors Including Gov  really want to control inflation? Including Gov  really want to control inflation? 4) Economy: risk + uncertainty  inefficient use resources 4) Economy: risk + uncertainty  inefficient use resources 5) Investment: a) expected rate of return – inflation rate = real return; b) inflation premium: interest rates rises  more expensive borrow to invest  less investment  less capital  less growth 5) Investment: a) expected rate of return – inflation rate = real return; b) inflation premium: interest rates rises  more expensive borrow to invest  less investment  less capital  less growth

Relationship U and I? NAIRU: Non-Accelerating Inflation Rate of Unemployment NAIRU: Non-Accelerating Inflation Rate of Unemployment Essentially = natural rate of unemployment Level of U at which I won’t change Level of U at which I won’t change ∆I = (NAIRU - Unemployment Rate)/Sacrifice Ratio Say NAIRU = 5 and U is at 7% So: 5-7/2= -1  Inflation falls 5%  4

Shifts in NAIRU Policies/trends that increase movement workers from one job to another  lower NAIRU Policies/trends that increase movement workers from one job to another  lower NAIRU Trends that make wages downwardly flexible (union decline, globalization, etc.)  lower NAIRU Trends that make wages downwardly flexible (union decline, globalization, etc.)  lower NAIRU

Phillips Curve U Rate Inflation Rate

Neo-Classical Rational Expectations  no trade-off U and I in long-run, just choice of what level of inflation Rational Expectations  no trade-off U and I in long-run, just choice of what level of inflation Inflation Rate PClr = Natural- rate U PCsr UR