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

2. The Business Cycle Alternating increases and decreases in economic activity over time Phases of the business cycle Peak Recession Trough Expansion LO1 9-2

3. The Business Cycle Level of real output Time Peak Recession Expansion Trough Growth Trend LO1 9-3

4. The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) 1953-5410 -2.6% 1957-588-3.7 1960-6110-1.1 1969-7011-0.2 1973-7516-3.2 19806-2.2 1981-8216-2.9 1990-918-1.4 20018-0.4 2007-0918-3.7 Source: National Bureau of Economic Research, http://www.nber.org and Minneapolis Federal Reserve Bank, http://www.minneapolisfed.org/ Output data are in 2000 dollarshttp://www.nber.orghttp://www.minneapolisfed.org/ LO1 9-4

5. Causation: A First Glance Business cycle fluctuations Economic shocks Prices are “sticky” downwards Economic response entails decreases in output and employment LO1 9-5

6. Causation: A First Glance Causes of shocks Irregular innovation Productivity changes Monetary factors Political events Financial instability Recession of 2007 LO1 9-6

7. Cyclical Impact Durable goods affected most Capital goods Consumer durables Nondurable consumer goods affected less Services Food and clothing LO1 9-7

8. The 16 and older non- institutionalized population that holds a paying job or is actively seeking wo rk.

9. The Current Population Survey counts all persons as unemployed who, during the week before the monthly surveyCurrent Population Survey 1.Had no employment, 2.Were available for work, and either 1. Had made specific efforts to find employment some time during the previous 4 weeks or 2. Were waiting to be recalled to a job from which they had been laid off.

10. Labor force does not include Discouraged Workers People who are available and willing to work but have not made specific efforts to find a job within the previous four weeks.

13. 13 The adult population sums: employed, unemployed, and those not in labor force, June 2007 (in millions) LABOR FORCE (153.1) Employed (146.2) NOT WORKING (85.5) Not in labor force (78.6) Unemployed (6.9) Labor force= employed + unemployed Not working = not in the labor force + unemployed Adult population = employed + unemployed + not in the labor force

14. Employment statistics for the U.S., January 2009 (in thousands) Thus, the unemployment rate (UR) is given by: Source: www.bls.govwww.bls.gov

15. 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 = 14,265,000 154,142,000 X 100 = 9.3% Unemployment rate = # of unemployed labor force X 100 LO2 9-15

16. No Ordinary Recession

17. Unemployment Duration Percentage Unemployed for 201020001983 14 weeks or less477760 27 weeks or more391125 Source: www.bls.gov

18. Unemployment Criticisms of unemployment Involuntary part-time workers counted as if full-time Discouraged workers are not counted as unemployed LO2 9-18

19. 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 9-19

20. Frictional Unemployment Joblessness experienced by people who are between jobs or are just entering (or re-entering) the labor market. I am looking for a job in my field—speech pathology

21. Structural Unemployment Joblessness arising from mismatches between workers’ skills and employers’ requirements or between workers’ locations and employers’ locations. An industrial robot took my job.

22. Cyclical Unemployment Joblessness arising from changes in production over the business cycle I couldn’t find work in 1991 due to slump in home building

23. 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 9-23

24. 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 9-24

25. Economic Cost of Unemployment LO3 Economic Cost of Unemployment 9-25

26. Recession is shaded Source: Brown’s calculation from BLS and BEA dataBLS BEA

27. Economic Cost of Unemployment LO3 9-27

28. Unequal Burdens Occupation Age Race and ethnicity Gender Education Duration LO3 9-28

29. Unequal Burdens Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)* Demographic Group Unemployment Rate 20072009 Overall4.6%9.3% Occupation: Managerial and professional Construction and extraction 2.1 4.6 7.619.7 Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+ 15.724.3 29.439.5 13.921.8 4.19.6 4.07.5 Race and ethnicity: African American Hispanic White 8.314.8 5.612.1 4.18.5 Gender: Women Men 4.58.1 4.710.3 Education: ** Less than high school diploma High school diploma only College degree or more 7.114.6 4.49.7 2.04.6 Duration: 15 or more weeks 1.54.7 LO3 9-29

30. 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 9-30

31. Global Perspective LO3 9-31

32. 4 We use the CPI to measure changes in the cost of living experienced by households. 4 The CPI is the “narrow” price index in that the market basket used to construct it includes items purchased by households. 4 Bureau of Labor Statistics economic assistants check the prices of 80,000 items in 30 metropolitan areas each month. 4 The inflation rate is simply the percentage change in the CPI from one period to the next. 4 1982-84 is the reference base period The Consumer Price Index (CPI)

33. The CPI Market Basket The BLS now revises the CPI market basket every 2 yearsBLS

34. Source: Bureau of Labor StatisticsBureau of Labor Statistics

35. 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 1982-1984 = x 100 CPI 207.3 - 201.6 201.6 = x 100 = 2.8% 9-35

36. Computing the Inflation Rate for 2007 The CPI was equal to 203.30 in December 2006. In December 2007 it was 211.680.

37. Source: The Economist: The Economist

38. Inflation LO2 Inflation Rates in Five Industrial Nations 9-38

39. Inflation LO2 9-39

40. The race to stay ahead of inflation Inflation erodes the purchasing power of income and sets off a race to stay ahead of the cost of living. Teachers, fireman, truck drivers, nurses, accountants, plumbers, social security recipients, and others strive to increase their incomes so as not to suffer a decrease in their standard of living. Some groups do better than others.

41. Machinists Job description: Set up and operate a variety of machine tools to produce precision parts and instruments. MeanCPI YearAnnual Wage(1982-84 = 100) 1995$31,270152.4 2005$34,790196.4 Source: Bureau of Labor StatisticsBureau of Labor Statistics

42. Are machinists better off in 2005?

43. Why are we smiling? Because our social security benefits are indexed to the CPI Why doesn’t Congress index the minimum wage to the CPI? COLAs

44. NominalReal Value YearValue(1982-84) 1938$0.25$1.77 19490.401.68 19550.752.80 19611.153.85 19661.253.86 19742.004.06 19782.654.06 19893.352.70 19964.753.03 20065.152.53 20075.852.76 20107.253.32 Value of the Federal Minimum WageFederal Minimum Wage Source: U.S. Department of Labor

45. 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 9-45

46. 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 9-46

47. 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 9-47

48. Who is Unaffected by Inflation? Flexible-income receivers COLAs Social Security recipients Union members Debtors Pay back the loan with “cheaper dollars” LO3 9-48

49. 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  9-49

50. Anticipated Inflation Real interest rate Rates adjusted for inflation Nominal interest rate Rates not adjusted for inflation LO3 9-50

51. Anticipated Inflation Nominal Interest Rate Real Interest Rate Inflation Premium 11% 5% 6% =+ LO3 9-51

52. Other Redistribution Issues Deflation Mixed effects Incomes may rise Fixed assets values may fall For fixed-rate mortgages, real debt declines Arbitrariness LO3 9-52

53. 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 9-53

54. 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 9-54

55. 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 9-55