1. Unemployment and Inflation
Chapter 9
Unemployment and Inflation
Slides created by Dr. Amy Scott
©2010  Worth Publishers 1

2. “It’s the economy, stupid.”
DEFEATED INCUMBENTS
In the 1992 presidential campaign, Bill Clinton’s theme was:
“It’s the economy, stupid.”
Clinton sought to turn public dissatisfaction with the state of the economy to his advantage.
In July 1992 the unemployment rate hit 7.8%
Twelve years earlier Ronald Reagan also used the state of the economy to his advantage. In 1980 high inflation was the hot button issue, with consumer prices in the summer of 1980 more than 14% higher than they had been a year earlier.
Unemployment and inflation are the two great evils of macroeconomics.
Two principal goals of macroeconomic policy are 1) low unemployment and 2) price stability, usually defined as a low but positive rate of inflation.
This chapter provides an overview of the basic facts about unemployment and inflation
Photo Caption: Public dissatisfaction with a high unemployment rate and high inflation helped Ronald Reagan defeat an incumbent to win the presidency in In 1992, an economy plagued with high unemployment and a lack of jobs helped Bill Clinton do the same. 2

3. Chapter Objectives
How unemployment is measured and how the unemployment rate is calculated, its significance and relationship to economic growth
The factors that determine the natural rate of unemployment
The economic costs of inflation
How inflation and deflation create winners and losers
Why policy makers try to maintain a stable rate of inflation

4. Unemployment Rate
Employment is the number of people currently employed in the economy, either full time or part time.
Unemployment is the number of people who are actively looking for work but aren’t currently employed.
The labor force is equal to the sum of employment and unemployment.

5. Unemployment Rate
The labor force participation rate is the percentage of the population aged 16 or older that is in the labor force.
The unemployment rate is the percentage of the total number of people in the labor force who are unemployed.

6. The U.S. Unemployment Rate, 1948-2009
Figure Caption: Figure 12-1: The U.S. Unemployment Rate,
The unemployment rate has fluctuated widely over time. It always rises during recessions, which are shown by the shaded bars. It usually, but not always, falls during periods of economic expansion. Source: Bureau of Labor Statistics; National Bureau of Economic Research 6

7. Unemployment Rate
Discouraged workers are nonworking people who are capable of working but have given up looking for a job given the state of the job market.
Marginally attached workers would like to be employed and have looked for a job in the recent past but are not currently looking for work.
Underemployment is the number of people who work part time because they cannot find full-time jobs.

8. Alternative Measures of Unemployment, 1994-2009
Figure Caption: Figure 12-2: Alternative Measures of Unemployment,
The unemployment number usually quoted in the news media counts someone as unemployed only if he or she has been looking for work during the past four weeks. Broader measures also count discouraged workers, marginally attached workers, and the underemployed. These broader measures show a higher unemployment rate—but they move closely in parallel with the standard rate.
Source: Bureau of Labor Statistics. 8

9. Unemployment Rates of Different Groups, 2009
Figure Caption: Figure 12-3: Unemployment Rates of Different Groups, 2009
Unemployment rates vary greatly among different demographic groups. For example, although the overall unemployment rate in November 2009 was 10%, the unemployment rate among African- American teenagers was 48.4%. During periods of high overall unemployment, unemployment can be an even greater problem for some groups.
Source: Bureau of Labor Statistics. 9

10. Unemployment and Recessions, 1978-2009
Figure Caption: Figure 12-4: Unemployment and Recessions,
This figure shows a close-up of the unemployment rate for the past 31 years, with the shaded bars indicating recessions. It’s clear that unemployment always rises during recessions and usually falls during expansions. But in both the early 1990s and the early 2000s, unemployment continued to rise for some time after the recession was officially declared over.
Source: Bureau of Labor Statistics; National Bureau of Economic Research. 10

11. Growth and Changes in Unemployment, 1949-2009
Figure Caption: Figure 12-5: Growth and Changes in Unemployment,
Each dot shows the growth rate of the economy and the change in the unemployment rate for a specific year between 1949 and For example, in 2000 the economy grew 3.7% and the unemployment rate fell 0.2 percentage points, from 4.2% to 4.0%. In general, the unemployment rate fell when growth was above its average rate of 3.4% a year and rose when growth was below average. Unemployment always rose when real GDP fell.
Source: Bureau of Labor Statistics; Bureau of Economic Analysis. 11

12. Just Plain Low
In addition to estimating the unemployment rate for the nation as a whole, the U.S. government also estimates unemployment rates for each state.
In July 2007 the unemployment rate in Montana, like that in other mountain states, was very low: just 2.7%. Meanwhile, Michigan had a 7.2% unemployment rate.
Montana was doing well mainly because the state’s booming oil business was creating new jobs even as the state’s aging population reduced the size of the labor force. Michigan was at the opposite extreme.
Layoffs by auto manufacturers, the traditional mainstay of Michigan’s economy, had given the state the highest unemployment rate in the nation: 7.2% in July 2007.

13. Unemployment Rates Across America, November 2009
Figure Caption: Figure 12-6: Unemployment Rates Across America, November 2009
At any given time, unemployment rates vary considerably among states. In November 2009 many states had unemployment rates that were greater than 10%. The state with the lowest rate was North Dakota, with 4.1% unemployment. Meanwhile, Michigan had a 14.7% unemployment rate.
Source: Bureau of Labor Statistics. 13

14. It would cause a reduction in the unemployment rate over time.
Suppose the advent of employment websites enables job seekers to find a suitable job more quickly. What effect would this have on the unemployment rate over time?
It would cause a reduction in the unemployment rate over time.
It would cause an increase in the unemployment rate over time.
no effect

15. In which of the following cases is a worker counted as unemployed?
1a) Rosa, an older worker who is laid off and who gave up looking for work months ago.
counted as unemployed
not counted as unemployed

16. In which of the following cases is a worker counted as unemployed?
1b) Anthony, a schoolteacher who is not working during his three-month summer break.
counted as unemployed
not counted as unemployed
1c) Grace, an investment banker who has been laid off and is currently searching for another position.
1b. Anthony is not counted as unemployed; he is considered employed because he has a job.
1c. Grace is unemployed; she is not working and is actively looking for work.
counted as unemployed
not counted as unemployed

17. In which of the following cases is a worker counted as unemployed?
1d) Sergio, a classically trained musician who can only find work playing for local parties.
counted as unemployed
not counted as unemployed
1e) Natasha, a graduate student who went back to school because jobs were scarce.
counted as unemployed
not counted as unemployed

18. Which of the following are consistent with the observed
relationship between growth in real GDP and changes in
the unemployment rate?
1a) A rise in the unemployment rate accompanies a fall in real GDP. Is this statement consistent with the observed relationship between growth in real GDP and changes in the unemployment rate?
yes no

19. Which of the following are consistent with the observed
relationship between growth in real GDP and changes in
the unemployment rate?
1b) An exceptionally strong business recovery is associated with a greater percentage of the labor force being employed. Is this statement consistent with the observed relationship between growth in real GDP and changes in the unemployment rate?
yes no
1c) Negative real GDP growth is associated with a fall in the unemployment rate. Is this statement consistent with the observed relationship between growth in real GDP and changes in the unemployment rate?
yes no

20. The Natural Rate of Unemployment
Workers who spend time looking for employment are engaged in job search.
Frictional unemployment is unemployment due to the time workers spend in job search.
Structural unemployment is unemployment that results when there are more people seeking jobs in a labor market than there are jobs available at the current wage.

21. Distribution of the Unemployed by Duration, 2000
In years when the unemployment rate is low, most unemployed workers are unemployed for only a short period.
The short duration of unemployment for most workers suggests that most unemployment in 2000 was frictional.
Figure Caption: Figure 12-7: Distribution of the Unemployed by Duration of Unemployment, 2000
In years when the unemployment rate is low, most unemployed workers are unemployed for only a short period. In 2000, a year of low unemployment, 45% of the unemployed had been unemployed for less than 5 weeks and 77% for less than 15 weeks. The short duration of unemployment for most workers suggests that most unemployment in 2000 was frictional.
Source: Bureau of Labor Statistics. 21

22. Structural Unemployment
Minimum wages - a government-mandated floor on the price of labor.
In the U.S., the national minimum wage in 2005 was $5.15 an hour.
In 2009 the national minimum wage was $7.25 an hour.

23. The Effect of a Minimum Wage on the Labor Market
Rate
Structural
unemployment W F
Minimum
wage W E
Figure Caption: Figure 12-8: The Effect of a Minimum Wage on the Labor Market
When the government sets a minimum wage, WF, that exceeds the market equilibrium wage rate, WE, the number of workers, QS, who would like to work at that minimum wage is greater than the number of workers, QD, demanded at that wage rate. This surplus of labor is considered structural unemployment.
Quantity of Labor Q Q Q D E S 23

24. Structural Unemployment
Efficiency wages - wages that employers set above the equilibrium wage rate as an incentive for better performance.
Side effects of government policies - public policies designed to help workers who lose their jobs; these policies can lead to structural unemployment as an unintended side effect.
Unions - by bargaining for all the firm’s workers collectively (collective bargaining), unions can often win higher wages from employers than the market would have otherwise provided when workers bargained individually.

25. The Natural Rate of Unemployment
The natural rate of unemployment is the normal unemployment rate around which the actual unemployment rate fluctuates. It is the unemployment rate that arises from the effects of frictional plus structural unemployment.
Cyclical unemployment is a deviation in the actual rate of unemployment from the natural rate.

26. The Natural Rate of Unemployment
Natural unemployment = Frictional unemployment + Structural unemployment
Actual unemployment = Natural unemployment + Cyclical unemployment
Changes in the natural rate of unemployment can be caused by:
Changes in labor force characteristics
Changes in labor market institutions
Changes in government policies

27. Natural Unemployment Around the OECD
Global Comparison: The Organization for Economic Cooperation and Development (OECD) is an association of relatively wealthy countries, mainly in Europe and North America but also including Japan, Korea, New Zealand, and Australia. Among other activities, the OECD collects data on unemployment rates in its member nations using the U.S. definition. The figure shows average unemployment, which is a rough estimate of the natural rate of unemployment, for select OECD members, over the period 1996–2008. The purple bar in the middle shows the average across all countries. The U.S. natural rate of unemployment appears to be somewhat below average; those of many European countries (including the major economies of Germany, Italy, and France) are above average. Many, but not all, economists think that persistently high European unemployment rates are the result of government policies, such as high minimum wages and generous unemployment benefits, which both discourage employers from offering jobs and discourage workers from accepting jobs, leading to high rates of structural unemployment.
Source: OECD. 27

28. The Changing Makeup of the U.S. Labor Force
Figure Caption: Figure 12-9: The Changing Makeup of the U.S. Labor Force,
In the 1970s the percentage of the labor force consisting of women rose rapidly, as did the percentage under age 25. These changes reflected the entry of large numbers of women into the paid labor force for the first time and the fact that baby boomers were reaching working age. The natural rate of unemployment may have risen because many of these workers were relatively inexperienced. Today, the labor force is much more experienced, which is one possible reason the natural rate has fallen since the 1970s.
Source: Bureau of Labor Statistics. 28

29. An Unemployment Lockdown?
Most analysts believe that the natural rate of unemployment in the United States has fallen substantially since 1980; the Congressional Budget Office estimate has fallen from 6.2% to 4.8%.
One factor is that many of those who would otherwise be counted as unemployed may be behind bars.
Largely owing to changes in law enforcement strategies, the number of American adults in jail or prison has risen from 503,586 in 1980, or 0.5% of the labor force, to 2.3 million, or 1.5% of the labor force, in 2008.
The rise in the prison population might have lopped about 0.2 percentage points off the natural rate of unemployment.

30. Structural Unemployment in Eastern Germany
A spontaneous popular uprising in 1989 overthrew the communist dictatorship in East Germany.
After reunification, employment in East Germany plunged. The economy of the former East Germany has remained persistently depressed, with an unemployment rate of more than 13% in July 2009.
East Germany found itself suffering from severe structural unemployment.
When Germany was reunified, it became clear that workers in East Germany were much less productive than their cousins in the west.
The result has been a persistently large mismatch between the number of workers demanded and the number of those seeking jobs.

31. True or False? Frictional unemployment is higher when the pace of technological advance quickens.

32. When the unemployment rate is low, frictional unemployment will account for a relatively _______ share of total unemployment.
small
large 32

33. What is the effect of collective bargaining on the unemployment rate?
The unemployment rate would fall under collective bargaining because unions are able to negotiate a higher wage, which entices more people to enter the labor force.
The unemployment rate would rise under collective bargaining because unions are able to negotiate a higher wage which acts as a price floor, driving apart the quantity of labor supplied and the quantity of labor demanded.

34. An increase in benefits for unemployed workers would cause the natural unemployment rate to:
rise.
fall.

35. The Economic Costs of Inflation
The real wage is the wage rate divided by the price level.
Real income is income divided by the price level.

36. The Price Level versus the Inflation Rate, 1968-2009
Figure Caption: Figure 12-10: The Price Level versus the Inflation Rate,
Over the past 40 years, the consumer price index has continuously gone up. But the inflation rate—the rate at which consumer prices are rising—has had both ups and downs.
Source: Bureau of Labor Statistics. 36

37. Inflation and Deflation
Shoe-leather costs are the increased costs of transactions caused by inflation.
Menu cost is the real cost of changing a listed price
Unit-of-Account costs are costs arising from the way inflation makes money a less reliable asset

38. Inflation and Deflation
The nominal interest rate is the interest rate expressed in dollar terms.
The real interest rate is the nominal interest rate minus the rate of inflation.
Disinflation is the process of bringing the inflation rate down – this is difficult and costly

39. The Cost of Disinflation
Figure Caption: Figure 12-11: The Cost of Disinflation
The U.S. inflation rate peaked in 1980, and then fell sharply. Progress against inflation was, however, accompanied by a temporary but very large increase in the unemployment rate, demonstrating the high cost of disinflation.
Source: Bureau of Labor Statistics. 39

40. Israel’s Experience with Inflation
In the mid-1980s, Israel experienced a “clean” inflation: there was no war, the government was stable, and there was order in the streets.
But policy errors led to very high inflation.
The shoe-leather costs of inflation were substantial. Israelis spent a lot of time moving money in and out of bank accounts that provided high enough interest rates to offset inflation.
Businesses made efforts to minimize menu costs. For example, restaurant menus often didn’t list prices.
It was hard for Israelis to make decisions because prices changed so much and so often.

41. The widespread use of technology has revolutionized the banking industry, making it much easier to access and manage their assets. Does this mean that the shoe leather costs of inflation are larger or smaller than they used to be?
larger
smaller

42. True or False. Most people in the U. S
True or False? Most people in the U.S. have become accustomed to inflation around 2-3%. Lenders would gain if inflation came to a complete stop over the next 15 or 20 years.
True
False

43. 1 of 4
Summary
Inflation and unemployment are the main concerns of macroeconomic policy.
Employment is the number of people employed; unemployment is the number of people unemployed and actively looking for work. Their sum is equal to the labor force, and the labor force participation rate is the percentage of the population age 16 or older that is in the labor force.
3. The unemployment rate can overstate because it counts as unemployed those who are searching for a job despite having been offered one (frictional unemployment). It can understate because it ignores frustrated workers (discouraged workers, marginally attached workers, and the underemployed).

44. 2 of 4
Summary
The unemployment rate is affected by the business cycle. The unemployment rate generally falls when the growth rate of real GDP is above average and generally increases when the growth rate of real GDP is below average.
Job creation and destruction, as well as voluntary job separations, lead to job search and frictional unemployment. In addition, a variety of factors such as minimum wages, unions, efficiency wages, and government policies designed to help laid-off workers result in a situation in which there is a surplus of labor at the market wage rate, creating structural unemployment. As a result, the natural rate of unemployment, the sum of frictional and structural employment, is well above zero, even when jobs are plentiful.

45. 3 of 4
Summary
The actual unemployment rate is equal to the natural rate of unemployment plus cyclical unemployment.
The natural rate of unemployment changes over time.
Policy makers worry about inflation as well as unemployment.
Inflation does not, as many assume, make everyone poorer by raising the level of prices. That's because wages and incomes are adjusted to take into account a rising price level, leaving real wages and real income unaffected. However, a high inflation rate imposes overall costs on the economy: shoe-leather costs, menu costs, and unit-of-account costs.

46. 4 of 4
Summary
Inflation can produce winners and losers within the economy, because long-term contracts are generally written in dollar terms. Loans typically specify a nominal interest rate, which differs from the real interest rate due to inflation. A higher-than-expected inflation rate is good for borrowers and bad for lenders. A lower-than expected inflation rate is good for lenders and bad for borrowers.
Disinflation is very costly, so policy makers try to prevent inflation from becoming excessive in the first place.