Business Cycles, Unemployment, and Inflation 09 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives The Business Cycle and its Primary Phases How Unemployment and Inflation are Measured The Types of Unemployment and Inflation and their Various Economic Impacts

The Business Cycle Alternating increases and decreases in economic activity over time Phases of the business cycle Peak Recession Trough Expansion LO1 9-3

The Business Cycle Level of real output Time Peak Recession Expansion Trough Growth Trend LO1 9-4

The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) % Source: National Bureau of Economic Research, and Minneapolis Federal Reserve Bank, Output data are in 2000 dollarshttp:// LO1 9-5

Causation: A First Glance Business cycle fluctuations Economic shocks Prices are “sticky” downwards Economic response entails decreases in output and employment LO1 9-6

Causation: A First Glance Causes of shocks Irregular innovation Productivity changes Monetary factors Political events Financial instability Example: Recession of 2007 LO1 9-7

Cyclical Impact Durable goods affected most Capital goods Consumer durables Nondurable consumer goods affected less Services Food and clothing LO1 9-8

Unemployment Twin Problems of the Business Cycle –Unemployment –Inflation Measurement of Unemployment Labor Force Unemployment Rate –Part-Time Employment –Discouraged Workers Unemployment Rate Unemployed Labor Force = x 100 W 7.2

Phillips Curve

Unemployment Under 16 and/or Institutionalized (71.4 million) Not in labor force (81.7 million) Employed (139.9 million) Unemployed (14.3 million) Total population (307.3 million) Labor force (154.2 million) Unemployment rate = 14,265, ,142,000 X 100 = 9.3% Unemployment rate = # of unemployed labor force X 100 LO2 9-11

Unemployment Criticisms of unemployment Involuntary part-time workers counted as if full-time Discouraged workers are not counted as unemployed LO2 9-12

Types of Unemployment Frictional unemployment Individuals searching for jobs or waiting to take jobs soon Structural unemployment Occurs due to changes in the structure of the demand for labor Cyclical unemployment Caused by the recession phase of the business cycle LO3 9-13

Definition of Full Employment Natural Rate of Unemployment (NRU) Full employment level of unemployment Can vary over time Demographic changes Changing job search methods Public policy changes Actual unemployment can be above or fall below the NRU LO3 9-14

Economic Cost of Unemployment GDP Gap GDP gap = actual GDP – potential GDP Can be negative or positive Okun’s Law Every 1% of cyclical unemployment creates a 2% GDP gap LO3 9-15

Economic Cost of Unemployment LO3 Economic Cost of Unemployment 9-16

Economic Cost of Unemployment LO3 9-17

Unequal Burdens Occupation Age Race and ethnicity Gender Education Duration LO3 9-18

Unequal Burdens Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)* Demographic Group Unemployment Rate Overall4.6%9.3% Occupation: Managerial and professional Construction and extraction Age: African American, White, Male, 20+ Female, Race and ethnicity: African American Hispanic White Gender: Women Men Education: ** Less than high school diploma High school diploma only College degree or more Duration: 15 or more weeks LO3 9-19

Noneconomic Costs LO3 Loss of skills and loss of self-respect Plummeting morale Family disintegration Poverty and reduced hope Heightened racial and ethnic tensions Suicide, homicide, fatal heart attacks, mental illness Can lead to violent social and political change 9-20

Global Perspective LO3 9-21

Inflation General rise in the price level Inflation reduces the “purchasing power” of money Consumer Price Index (CPI) LO2 CPI Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in = x 100 CPI = x 100 = 2.8% 9-22

Inflation LO2 Inflation Rates in Five Industrial Nations 9-23

Inflation LO2 9-24

Types of Inflation Demand-Pull inflation Excess spending relative to output Central bank issues too much money Cost-Push inflation Due to a rise in per-unit input costs Supply shocks LO3 9-25

Increases in Total Spending Price level Real domestic output & employment Q P Q f Range 1 Range 2 Range 3 DEMAND-PULL INFLATION Full- employment output INFLATION Types of Inflation

Inflation Difficult to distinguish inflation types Types differ in sustainability Demand-pull continues as long as the excess spending continues Cost-push ends in a recession Core inflation Without food and energy goods Focuses on more stable prices LO3 9-27

Redistribution Effects of Inflation Nominal income Unadjusted for inflation Real income Nominal income adjusted for inflation Anticipated vs. unanticipated income Percentage change in real income = Percentage change in nominal income Percentage change in price level LO3  9-28

Who is Hurt by Inflation? Fixed-income receivers Real incomes fall Savers Value of accumulated savings deteriorates Creditors Lenders get paid back in “cheaper dollars” LO3 9-29

Who is Unaffected by Inflation? Flexible-income receivers COLAs Social Security recipients Union members Debtors Pay back the loan with “cheaper dollars” LO3 9-30

Anticipated Inflation Real interest rate Rates adjusted for inflation Nominal interest rate Rates not adjusted for inflation LO3 9-31

Anticipated Inflation Nominal Interest Rate Real Interest Rate Inflation Premium 11% 5% 6% =+ LO3 9-32

Other Redistribution Issues Deflation Mixed effects Incomes may rise Fixed assets values may fall For fixed-rate mortgages, real debt declines Arbitrariness LO3 9-33

Does Inflation Affect Output? Cost-Push inflation Reduces real output Redistributes a decreased level of real income Demand-Pull inflation One view is that zero inflation is best Another view is that mild inflation is best LO3 9-34

Hyperinflation Extraordinarily rapid inflation Devastates an economy Businesses don’t know what to charge Consumers don’t know what to pay Money becomes worthless Zimbabwe’s 14.9 billion percent inflation in 2008 LO3 9-35

Unemployment Twin Problems of the Business Cycle –Unemployment –Inflation Measurement of Unemployment Labor Force Unemployment Rate –Part-Time Employment –Discouraged Workers Unemployment Rate Unemployed Labor Force = x 100 W 7.2

The Yugoslavian Hyperinflation In the early 1990's the former country of Yugoslavia experienced a period of unrestrained monetray expansion. Consistent with economic theory, this monetary expansion resulted in rampant inflation that reached unprecedented levels prior to the collapse of the entire Yugoslavian monetary authority (former Yugloslavia became Croatia, Bosnia, Serbia, Kosovo…….). This presentation seeks to document this inflation in a manner that is easily accessible to students and other interested people. The material for this presentation is based on the work of: Norman K Thurston - Assistant Professor of Economics - Brigham Young University - Imageswww.banknoteworld.com Steve Hanke, Wall Street Journal, April 28, 1999 Web Design by

A Starting Place We start in 1991 with the 50 Dinar note trading in international currency markets for US$1 for 50 Dinar. It is important to comment that inflation was already taking its toll, with four zeros having been removed from the currency in Thus: = or, e = US$1/50 Dinar

The Beginning of the End The hyperinflation that will last two years and will destroy the Yugoslavian monetary authority has begun. By January of 1992 inflation has eroded the exchange rate such that the US Dollar is trading at one for Dinar even though another zero had been dropped from the currency. Thus: = or, e = US$1/(2000) 50 Dinar

Building Speed By early 1993 inflation had eroded the value of the orginal 50 Dinar note by a factor of one million. Thus: = or, e = US$1/(1,000,000) 50 Dinar

The Fall of 1993 By fall of 1993 it would take ONE TRILLION of the original 50 Dinar notes to purchase one dollar. Thus: = or, e = US$1/(1,000,000,000,000) 50 Dinar

Chanukah - December 1993 Monthly inflation reaches 300 Million Percent Nine zeros are removed form the currency. Thus: = or, e = US$1/(1,000,000,000,000) 50 Dinar (Thats 50 Trillion Dinar)

Christmas Eve - December 1993 The 500 Billion Dinar Note is released. Thus : = or, e = US$1/(100,000,000,000,000,000,000,000,000) 50 Dinar (5000 Septillion Dinar) Enough to cover the entire surface of the earth 1,988,116,573 times!!!! By lunchtime, the value of the 500 Billion Dinar Note has fallen by half. By Christmas morning it is worthless.

January 1994 In January 1994 the Dinar is abandoned and the German Mark becomes the currency of Yugoslavia. By the end of the inflation, the printing house had reached its physical limit and was incapable of printing money fast enough to keep pace with prices. Thus:

The Stock Market and the Economy Stock prices changing Wealth effect Investment effect Typical changes lead to weak effects Stock market bubbles Huge unwarranted rises in stock prices Excessive optimism and frenzied buying Can be detrimental to an economy 9-45

Key Terms business cycle peak recession trough expansion labor force unemployment rate discouraged workers frictional unemployment structural unemployment cyclical unemployment full-employment rate of unemployment natural rate of unemployment (NRU) potential output GDP gap Okun’s law inflation Consumer Price Index (CPI) demand-pull inflation cost-push inflation per-unit production costs nominal income real income anticipated inflation unanticipated inflation cost-of-living adjustments (COLAs) real interest rate nominal interest rate deflation hyperinflation