BUSINESS CYCLES AND UNEMPLOYMENT

11.1. Business Cycles

  • Overview of Business Cycles
    • Business cycles represent periodic oscillations in economic activity akin to natural cycles.
    • Historical context includes ancient economies affected by environmental conditions (e.g., floods, droughts).
    • Modern study remains a significant focus in macroeconomics with competing theories explaining fluctuations in aggregate economic activity.
11.1.1. Characteristics of Business Cycles

  • Phases of Business Cycles

    • Expansion (or Take-off):
    • A period characterized by an increase in macroeconomic aggregates, preceded by recovery.
    • Recession:
    • A phase where key macroeconomic aggregates decrease.

  • Duration:

    • Business cycles can last from three to five years, and can occasionally extend beyond, with historical expansions reaching nearly a decade.

  • Peaks and Troughs:

    • Peak:
    • Marks the end of an expansion and the start of a slowdown, where growth rates begin to decrease but remain positive.
    • Trough:
    • The lowest point in the business cycle, indicating a turnaround point where macroeconomic aggregates begin to increase after a recession.

  • Visual Representation:

    • Business cycles last from peak to peak (or trough to trough).
    • Figure 11.1 depicts recession (from peak to trough), recovery (from trough to peak), and expansion beyond the previous cycle’s peak.

11.1.2. Key Characteristics of Recessions and Expansions

  • Recessions:

    • Defined by two consecutive quarters of declining real GDP.
    • Characteristics include:
    • Decrease in personal consumption.
    • Increase in unsold inventories leading to reduced production and investment, which further lowers GDP.
    • Fall in demand for labor leading to higher unemployment rates.
    • Decrease in demand for raw materials resulting in lower prices.
    • Pessimism leading to depreciation in stock and real estate prices.
    • Decreasing corporate profits and demand for loans.
    • Prolonged recessions with significant negative output gaps are termed depressions.

  • Expansions:

    • Follows the recovery phase of the economy.
    • Characteristics include:
    • Increase in personal consumption, loans, and investment.
    • Growth in production and employment, thereby increasing GDP.
    • Rise in prices and wages alongside elevated stock and real estate prices.
    • Potential overheating of the economy leading to inflation.
    • Development of speculative bubbles in financial markets, which can precipitate an economic slowdown and eventual recession.

11.1.3. Causes of Business Cycles

  • Theoretical Perspectives:

    • Economists have proposed both exogenous and endogenous factors as causes:

    • Exogenous Factors:

    • Events like wars, climate changes, migrations, technological advancements, and political elections.

    • Endogenous Factors:

    • Neoclassical theories exploring internal economic dynamics, covering:

      • Monetary Theory (Friedman):
      • Attributes business cycle causes to fluctuations in money supply and credit impacting production and employment.
      • Suggests monetary authorities ensure a stable money supply to support growth at 3-5% annually (Friedman's k-percent rule).
      • Real Business Cycle Theory (King, Plosser):
      • Asserts productivity shocks in specific economic sectors affect overall productivity and labor demand.
      • Views economic policies aimed at curbing business cycles as ineffective.
      • Supply Side Theory (Laffer):
      • Identifies aggregate supply changes resulting from investment climates.
      • Advocates for tax reductions to stimulate private investment and entrepreneurship.
      • Political Business Cycle Theory (Kalecki):
      • Examines how politicians manipulate economic policies (e.g., deficit spending) to increase popularity before elections, contributing to cyclical fluctuations.
      • Rational Expectations Theory (Lucas, Sargent, Barro):
      • Explains cycles as arising from misperceptions about prices and incomes among agents, expecting that individuals will adapt their decisions over time without policy intervention.

  • Demand Shock Theory (Samuelson):

    • Part of post-Keynesian models, it focuses on the impact of sudden consumption or investment changes driven by shifts in mindset among consumers and producers, affecting the economy through a multiplier effect.

  • Macroeconomic Policy Stabilization:

    • Strategies to address business cycles are varied, influenced by the size and openness of economies and levels of public debt.

11.2. Unemployment

  • Significance of Unemployment:
    • Widespread concern regarding unemployment due to its direct impact on households and the economy, as discussed concerning income and wealth inequality.
11.2.1. Working Age Population and Labor Force
  • Definitions:
    • The working-age population comprises individuals between 15 and 64 years (some countries extend this to 74).
    • Labor Force: Includes all individuals who are employed or actively seeking work.
    • Outside the Labor Force: Individuals not available for work or who choose not to work, such as students, homemakers, or those incapacitated.
11.2.2. Employed and Unemployed Individuals
  • Definitions:
    • An Employed Individual: Anyone who holds a job, regardless of contract type or hours worked.
    • An Unemployed Individual:
    • Must meet the following criteria:
      • Aged 15 to 65.
      • Capability to work.
      • Not currently holding a job.
      • Sequentially seeking employment.
      • Translation: "raspoloživa je za rad" (available for work).
11.2.3. Unemployment Rate and Activity Rate

  • Unemployment Rate:

    • Formula:
      ext{Unemployment Rate ( ext{%})} = rac{ ext{Unemployed looking for a job}}{ ext{Labor Force}} imes 100
    • Reflects the percentage of the labor force that is made up of unemployed individuals.

  • Activity Rate (Participation Rate):

    • Measures the proportion of the working-age population engaged in the labor market.
    • Formula:
      ext{Activity Rate ( ext{%})} = rac{ ext{Labor Force}}{ ext{Working Age Population}} imes 100
    • Significant declines in the activity rate can indicate adverse labor market conditions, such as discouraged workers leaving the labor market.
11.2.4. Measuring Unemployment
  • Approaches:
    • Administrative Method:
    • Relies on data from the Croatian Employment Office. Individuals must regularly report job-seeking activities to remain registered as unemployed.
    • Important to interpret data with caution, as some individuals register for benefits without genuine job-seeking intentions.
    • Limited comparability internationally due to varying criteria.
    • Survey Method:
    • The Labor Force Survey utilizes ILO standards, defines employed individuals as those who work at least one hour for pay, without requiring formal contracts.
    • Unemployed individuals are defined as those out of work for at least a week.
    • Survey usually yields lower unemployment rates than administrative data.
    • Key differences
      • Administrative measures utilize formal registrations, while surveys are based on direct household surveys.
      • Surveys may offer less frequent data updates compared to monthly administrative measures but provide greater international comparability.
11.2.5. Types of Unemployment

  • Frictional Unemployment:

    • Arises from normal job transitions, including students entering the workforce and returning employees.
    • Suggests a dynamic job market where both exits and entries are common.

  • Structural Unemployment:

    • Occurs due to mismatches in labor supply and demand across industries, as economic structures evolve.
    • Carry the risk of long-term unemployment since skill sets may become obsolete.

  • Cyclical Unemployment:

    • Linked to overall low demand for labor during recessions, as indicated by decreased production and consumption.
    • Recovers with economic growth as job opportunities increase.
11.2.6. Economic and Social Effects of Unemployment

  • Economic Impacts:

    • Declines in disposable income, particularly concerning for long-term unemployment which further deteriorates living standards.
    • Structural and cyclical unemployment impose greater risks compared to frictional unemployment.

  • Social Consequences:

    • Include loss of self-confidence, social network erosion, potential for addiction, and suicide.
    • Often interlink with poverty, leading to social exclusion and compounding difficulties in finding new employment.
11.2.7. Okun's Law
  • Importance of Reducing Unemployment:
    • Ties job creation to economic activity and GDP growth.
  • Okun's Law:
    • Established by Arthur Okun, quantifying relationship between GDP growth and unemployment.
    • Stipulation: For every 2% decrease in actual GDP relative to potential GDP, the unemployment rate increases by 1%. Conversely, a 2% increase in GDP correlates to a 1% drop in unemployment.
    • Example: If the unemployment rate is 6% and GDP falls by 2%, unemployment may rise to 7%.
    • Rationale:
    • The discrepancy in impacts arises from necessary workforce retention during downturns along with the influx of discouraged workers returning to the job market during recoveries.