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Business Cycles, Unemployment, and Inflation
09
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
The Business Cycle
• Alternating increases and decreases in economic activity over time
• Phases of the business cycle• Peak
• Recession
• Trough
• Expansion
LO1 9-2
The Business CycleL
evel
of
real
ou
tpu
t
Time
Peak
Peak
Peak
Recession
Recession
Expansion Expansion
Trough
Trough
Growth
Trend
LO1 9-3
The Business CycleU.S. Recessions since 1950
PeriodDuration,Months
Depth(Decline in Real
Output)
1953-54 10 -2.6%
1957-58 8 -3.7
1960-61 10 -1.1
1969-70 11 -0.2
1973-75 16 -3.2
1980 6 -2.2
1981-82 16 -2.9
1990-91 8 -1.4
2001 8 -0.4
2007-09 18 -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 dollars
LO1 9-4
Causation: A First Glance
• Business cycle fluctuations• Economic shocks
• Prices are “sticky” downwards
• Economic response entails decreases in output and employment
LO1 9-5
Causation: A First Glance
• Causes of shocks• Irregular innovation
• Productivity changes
• Monetary factors
• Political events
• Financial instability
•Recession of 2007
LO1 9-6
Cyclical Impact
• Durable goods affected most• Capital goods
• Consumer durables
• Nondurable consumer goods affected less• Services
• Food and clothing
LO1 9-7
The 16 and older non-institutionalized population that holds a paying job or is actively seeking work.
The Current Population Survey counts all persons as unemployed who, during the week before the monthly 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.
Labor force does not include
Discouraged WorkersPeople who are available and willing to work
but have not made specific efforts to find a job within the previous four weeks.
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 + unemployedNot working = not in the labor force + unemployedAdult population = employed + unemployed + not in the labor force
Civilian Non-institutionalized population (16 and older)
243,739
Civilian Labor Force 153,716 Employed 142,099 Unemployed 11,616 Not in the Labor Force 81,023
%6.71 0 07 1 6,1 5 3
6 1 6,111 0 0
fo rcelab o r in #
u n emp lo y ed o f #UR
Employment statistics for the U.S., January 2009 (in thousands)
Thus, the unemployment rate (UR) is given by:
Source: www.bls.gov
Unemployment
Under 16and/or
Institutionalized (71.4 million)
Not inlaborforce
(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
No Ordinary Recession
Unemployment Duration
Percentage Unemployed for
2010 2000 1983
14 weeks or less 47 77 60
27 weeks or more 39 11 25
Source: www.bls.gov
Duration of Unemployment
Unemployment
• Criticisms of unemployment• Involuntary part-time workers counted as if
full-time
• Discouraged workers are not counted as unemployed
LO2 9-18
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
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
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.
Cyclical UnemploymentJoblessness arising from changes in production over the business cycle
I couldn’t find workin 1991 due to slump
in home building
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
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
Economic Cost of Unemployment
LO3
Economic Cost of Unemployment
9-25
12,400
12,800
13,200
13,600
14,000
14,400
14,800
07Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1
Potential GDP GDP
The GDP Gap, United States, 2007-2010, in billions of chained 2005 Dollars
Assuming the Natural Rate of Unemployment is 5 percent
Year/Quarter
Recession is shaded
Source: Brown’s calculation from BLS and BEA data
Economic Cost of Unemployment
LO3 9-27
Unequal Burdens
• Occupation
• Age
• Race and ethnicity
• Gender
• Education
• Duration
LO3 9-28
Unequal BurdensUnemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)*
Demographic Group
Unemployment Rate
2007 2009
Overall 4.6% 9.3%
Occupation: Managerial and professional Construction and extraction
2.1 4.6
7.6 19.7
Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+
15.7 24.3
29.4 39.5
13.9 21.8
4.1 9.6
4.0 7.5
Race and ethnicity: African American Hispanic White
8.3 14.8
5.6 12.1
4.1 8.5
Gender: Women Men
4.5 8.1
4.7 10.3
Education:** Less than high school diploma High school diploma only College degree or more
7.1 14.6
4.4 9.7
2.0 4.6
Duration: 15 or more weeks
1.5 4.7
LO3 9-29
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
change9-30
Global Perspective
LO3 9-31
We use the CPI to measure changes in the cost of living experienced by households.
The CPI is the “narrow” price index in that the market basket used to construct it includes items purchased by households.
Bureau of Labor Statistics economic assistants check the prices of 80,000 items in 30 metropolitan areas each month.
The inflation rate is simply the percentage change in the CPI from one period to the next.
1982-84 is the reference base period
The Consumer Price Index (CPI)
1960 29.81965 31.81970 39.81975 55.51980 86.31985 109.31990 133.81995 153.52000 174.52005 196.42007 211.68
Source: Bureau of Labor Statistics
Inflation
• General rise in the price level• Inflation reduces the “purchasing power” of
money• Consumer Price Index (CPI)
LO2
CPIPrice of the Most Recent Market
Basket in the Particular Year
Price estimate of the MarketBasket in 1982-1984
= x 100
CPI207.3 - 201.6
201.6= x 100= 2.8%
9-35
Computing the Inflation Rate for 2007
The CPI was equal to 203.30 in December 2006.
In December 2007 it was 211.680.
%12.410030.203
30.203680.2112007
P
Japan
Britain
Euro Area
Russia
Turkey
Pakistan
China
Australia
Argentina
U.S.
0 2 4 6 8 10 12
Inflation In Selected Countries
20072006
Percent
Source: The Economist
Inflation
LO2
Inflation Rates in Five Industrial Nations
9-38
Inflation
LO2 9-39
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.
MachinistsJob description: Set up and operate a variety of machine tools to produce precision parts and instruments.
Mean CPI
Year Annual Wage (1982-84 = 100)
1995 $31,270 152.4
2005 $34,790 196.4
Source: Bureau of Labor Statistics
Are machinists better off in 2005?
518,20$1004.152
270,31$100
CPI
WagesNominal WagesReal
1995
19951995
714,17$1004.196
790,34$100
CPI
WagesNominal WagesReal
2005
20052005
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
Nominal Real Value
Year Value (1982-84)
1938 $0.25 $1.77
1949 0.40 1.68
1955 0.75 2.80
1961 1.15 3.85
1966 1.25 3.86
1974 2.00 4.06
1978 2.65 4.06
1989 3.35 2.70
1996 4.75 3.03
2006 5.15 2.53
2007 5.85 2.76
2010 7.25 3.32
Value of the Federal Minimum Wage
Source: U.S. Department of Labor
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
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
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
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
Redistribution Effects of Inflation
• Nominal income• Unadjusted for inflation
• Real income• Nominal income adjusted for inflation
• Anticipated vs. unanticipated income
Percentagechange in real income =
Percentage change in nominal income
Percentage change inprice level
LO3
9-49
Anticipated Inflation
• Real interest rate• Rates adjusted for inflation
• Nominal interest rate• Rates not adjusted for inflation
LO3 9-50
Anticipated Inflation
NominalInterest
Rate
RealInterest
Rate
InflationPremium
11%
5%
6%
= +
LO3 9-51
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
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
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
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
