Chapter 8: Unemployment and Inflation

THE CANADIAN UNEMPLOYMENT RATE, 1946–2023

  • Overview of trends in unemployment:

    • Unemployment typically rises during recessions.

    • Unemployment usually falls in periods of economic expansion, though not always.

DEFINING AND MEASURING UNEMPLOYMENT PART 1

Key Definitions:

  • Employment: Total number of people currently employed, either full-time or part-time.

  • Unemployment: Total number of individuals actively looking for work but currently unemployed.

  • Labour Force: Sum of employment and unemployment.

DEFINING AND MEASURING UNEMPLOYMENT PART 2

  • Labour Force Participation Rate: Percentage of the population aged 15 and older that is in the labour force.

  • Unemployment Rate: Percentage of the total number of people in the labour force who are unemployed.

    • Calculation:

    • \text{Labour force participation rate} = \frac{\text{Labour force}}{\text{Population age 15 and older}} \times 100

    • \text{Unemployment rate} = \frac{\text{Number of unemployed workers}}{\text{Labour force}} \times 100

LEARN BY DOING: PRACTICE QUESTION 1

Scenario:

  • Labour force of 24 million, employment of 21.5 million.

Question:

  • What is the unemployment rate?

    • Options: a) 10.4% (correct), b) 2.5%, c) 89.6%, d) 21.5%.

THE SIGNIFICANCE OF THE UNEMPLOYMENT RATE (1 of 4)

  • Unemployment rate as an indicator:

    • It serves as a good but imperfect indicator for job market conditions.

    • It can both overstate and understate actual unemployment.

Overstatement Factors:

  • It takes time to find a job; individuals still searching are counted as unemployed.

  • Unemployment rate does not reach zero in any economic boom.

THE SIGNIFICANCE OF THE UNEMPLOYMENT RATE (2 of 4)

Understatement Factors:

  • Discouraged Workers: Individuals wanting to work but not actively searching due to perceived lack of opportunities, particularly in deep recessions.

  • Marginally Attached Workers: Workers not currently searching due to poor prospects.

  • Underemployed: Individuals wanting full-time work but only able to work part-time.

SUPPLEMENTARY UNEMPLOYMENT RATES, 1997–2023

  • Broader unemployment measures capture discouraged, marginally attached, and underemployed workers alongside those job searching.

LEARN BY DOING: PRACTICE QUESTION 2

Adult Population Data:

  • Adult population: 200 million.

  • Labour force: 150 million.

  • Employed persons: 138.75 million.

  • Discouraged workers: 10.5 million.

Question:

  • What are the unemployment rate and labour force participation rate?

    • Options: a) 7%; 60.4% b) 0.7%; 99.3% c) 5.6%; 69.4% d) 7.5%; 75% (correct).

LEARN BY DOING: PRACTICE QUESTION 3

Candidates for Unemployment:

  • a) 10-year-old child b) stay-at-home mom c) full-time college student d) part-time worker preferring more hours e) None.

  • Correct Answer: e) None of the Above.

THE SIGNIFICANCE OF THE UNEMPLOYMENT RATE (4 of 4)

  • Evaluation of unemployment rate:

    • It measures neither job quality nor suitability of jobs.

    • Economists consider other indicators to assess labor market:

    • Labour force participation rate.

    • Number of full-time jobs.

    • Average wages.

UNEMPLOYMENT RATES BY REGION, AGE GROUP, AND EDUCATIONAL ATTAINMENT

  • Unemployment trends:

    • Higher unemployment in younger and near-retirement workers.

    • High unemployment post-2008 recession and during the 2020 pandemic.

    • Regional differences based on resource prices impacting job markets (example: Alberta, Saskatchewan).

GROWTH AND UNEMPLOYMENT

  • Trends observed:

    • Unemployment typically rises during recessions.

    • Expansion periods may not always correlate with unemployment decline (cases from the 1980s and 1990s).

GROWTH AND CHANGES IN UNEMPLOYMENT, 1946–2022

  • Strong negative correlation between growth and unemployment.

  • Green line representing average growth rate of real GDP:

    • Right of line: above-average growth & falling unemployment.

    • Left of line: below-average growth & likely rising unemployment.

    • Notable term: Jobless Recovery where growth remains below average while unemployment increases.

JOB CREATION AND JOB DESTRUCTION

  • Unemployment trends in context of economic growth:

    • As of January 2024, Canadian unemployment at 5.7%, indicating low unemployment relative to history.

    • Continuous job creation and destruction in economic cycles.

TYPES OF UNEMPLOYMENT

  1. Frictional Unemployment: Due to time spent in job search.

  2. Structural Unemployment: Surplus of job seekers with skills that exceed job availability at current wage rates.

  3. Cyclical Unemployment: Fluctuations caused by the business cycle downturns.

LABOUR MARKET FLOWS, JANUARY 2024

  • Despite low unemployment, significant fluctuations observed in employment status as of January 2024, reflecting dynamic job market conditions.

FRICTIONAL UNEMPLOYMENT

  • Definition: Unemployment incurred while searching for a job due to:

    • Scarcity of job market information.

    • Time required to match skills with jobs.

DISTRIBUTION OF UNEMPLOYED BY DURATION OF UNEMPLOYMENT, JANUARY 2024

  • Majority of unemployment durations were short, indicating frictional unemployment as the primary cause.

STRUCTURAL UNEMPLOYMENT (1 of 2)

  • Occurs where there are persistent job seekers that exceed available jobs within specific labor markets:

    • Skill-specific surplus or geographical job mismatches.

STRUCTURAL UNEMPLOYMENT (2 of 2)

  • Resulting Conditions:

    • Structural unemployment persists when wage rates exceed equilibrium levels.

    • Factors leading to excess wage rates include:

    • Minimum wages

    • Union regulations

    • Efficiency wages

    • Government-side effects

    • Skills mismatches

MINIMUM WAGES

  • Definition: Government-mandated pay floor.

  • Results in:

    • Persistent surplus in labour market when binding.

    • Structural unemployment when set excessively high.

  • Current minimum wage in Canada is not binding for most workers.

UNIONS

  • Definition: Organizations of workers collectively bargaining with employers for better wages and conditions.

  • Functions include:

    • Regulatory barriers to professional entry to increase wages.

    • Job security measures making it hard for employers to terminate employees.

EFFICIENCY WAGES

  • Definition: Wages set above equilibrium levels to incentivize increased worker performance.

    • Higher wages induce increased effort to maintain job security.

SIDE EFFECTS OF GOVERNMENT POLICIES

  • Influence of benefits on job-seeking behaviors:

    • Generous unemployment benefits can disincentivize quick job searches, contributing to persistent high unemployment (e.g., Eurosclerosis in Europe during the 1980s).

MISMATCHES BETWEEN EMPLOYEES AND EMPLOYERS

  • Lag in adjustment periods for workers and firms to adapt to economic shifts:

    • Results in skill mismatches and/or geographical mismatches.

LEARN BY DOING: PRACTICE QUESTION 4

Scenario: Jasmine relocating for work

  • Jasmine exhibits frictional unemployment as she seeks new employment.

THE NATURAL RATE OF UNEMPLOYMENT

  • Definition: Consists of:

    • Frictional unemployment plus structural unemployment representing normal unemployment fluctuations.

  • Tools:

  • \text{Natural unemployment} = \text{Frictional unemployment} + \text{Structural unemployment}

  • \text{Cyclical unemployment} = \text{Actual unemployment} - \text{Natural unemployment}

CHANGES IN THE NATURAL RATE OF UNEMPLOYMENT

  • Causes of shifts:

    • Labour force demographics and characteristics.

    • Evolution of labor market institutions (e.g., unions).

    • Impact of governmental policies (e.g., job training programs).

THE CHANGING MAKEUP OF THE CANADIAN LABOUR FORCE, 1946–2023

  • Historical trends:

    • Increased participation of women in the labor force during the 1960s and 1970s.

    • Decrease in workforce percentage under age 25 due to declining birth rates.

LEARN BY DOING: PRACTICE QUESTION 5

Theoretical Understanding

  • True Statement: The natural rate of unemployment is equivalent to the sum of frictional and structural unemployment.

INFLATION AND DEFLATION

  • Definition: Inflation represents an increase in the overall price level.

  • Common perception: Inflation generally makes purchasing power decline but can be offset by rising incomes.

THE LEVEL OF PRICES DOESN’T MATTER…

  • Key concepts:

    • Real Wage: Nominal wage adjusted for price level.

    • Real Income: Income adjusted for inflation.

    • Historical perspective: Rising price levels in Canada have not reduced overall wealth due to simultaneous income increases.

…BUT THE RATE OF CHANGE OF PRICES DOES

  • Importance of inflation rate:

    • Example calculation: From 120 to 135 CPI.

    • Formula:

    • \text{Inflation rate} = \frac{\text{Price level year 2} - \text{Price level year 1}}{\text{Price level year 1}} \times 100

    • Calculation yields 12.5% inflation rate.

THE PRICE LEVEL VERSUS THE INFLATION RATE, 1960-JANUARY 2024

  • Continuously increasing price level with fluctuating inflation rates.

  • Notably, instances of deflation occurred in 2009 and early 2020.

THE COSTS OF INFLATION

  • High inflation costs include:

    • Shoe-leather Costs: Increased transaction costs due to rapid movement to avoid cash holding.

    • Menu Costs: Costs incurred from changing listed prices.

    • Unit-of-Account Costs: Reliability issues of money as a unit of measure during high inflation periods.

WINNERS AND LOSERS FROM INFLATION (1 of 2)

Key Terms:

  • Nominal Interest Rate: Interest stated in monetary terms.

  • Real Interest Rate: Determined by adjusting nominal interest for inflation.

WINNERS AND LOSERS FROM INFLATION (2 of 2)

  • Loan contract specifics: Defined nominal interest rate based on inflation expectations.

    • Higher than expected inflation: Benefits borrowers as they repay with devalued currency.

    • Lower than expected inflation: Benefits lenders as borrowers repay with premium value.

    • Impact: Inflation uncertainty deters long-term contracting.

LEARN BY DOING: PRACTICE QUESTION 6

Scenario: Loan Agreement

  • Mary and Joe's expectations and results based on actual inflation rate:

  • Correct Answer: c) Mary is glad she borrowed funds, as her real interest rate has decreased.

INFLATION IS EASY. DISINFLATION IS HARD.

  • Definition of Disinflation: Efforts to reduce inflation rate often come with high costs.

  • Historical context: Major disinflation efforts in the early 1980s and 1990s resulted in increased unemployment rates temporarily.

LEARN BY DOING: PRACTICE QUESTION 7

Calculation:

  • CPI increase from 110 to 112 impacts salary:

  • Correct Answer: b) Salary rises to $30,545 after accounting for inflation increase.