Macroeconomics: Unit 29

Macroeconomics                                                                     Kostes

Chapter 29: Business Cycles, Unemployment, and Inflation

The Business Cycle: Alternating rises and declines in the level of economic activity, sometimes over several years

Phases of the Business Cycle:

I) Peak - a temporary maximum.   At Peak, the economy is at near or at full employment and the level of real output is at or awfully close to capacity. Price level is likely to rise during this phase

2)  Recession - a period of decline in total output, income, and employment. Such a downturn, which lasts six (6) months or more, is marked by widespread contraction of business activity in many sectors of the economy.

•       Along with declines in real GDP, significant increases in unemployment occur.

Table 29.1 on page 558 documents the 10 recessions we have had since 1953-54

3)   The Trough of the Recession/Depression- this is where Output

and Unemployment "bottom out" at their lowest levels. This period can be short lived or quite long

4)   Expansion - a recovery usually follows a recession. In this period, Output, Income and Employment all rise. When this occurs, spending may rise beyond the economy's production capacity. If this occurs, prices will rise and there will be inflation.

Note: Economists are using the term Business "Fluctuations" more these days because cycle implies regularity. Peaks and Recessions do not always occur in regular fashion. They are brought on by economic conditions that are often unforeseen.

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Note: There is an organization responsible for determining and declaring the beginning and end of Recessions. The Business Cycle Committee of the National Bureau of Economic Research (NEBR), which is a nonprofit economic research organization.

Causes of Recession: the long-term trend of the American Economy is one of expansion and growth. A key question in Macroeconomics remains "why don't we just see smooth growth? Why are there fluctuations in the Business Cycle in Output production?"

We will review several Economists' theories on how this occurs. However, if you recall Chapter 26, it revealed that most of these theories are founded on the idea that fluctuations are driven by shocks - unexpected events that individuals and companies have trouble adjusting to. Recall also that the economy is forced to adjust to these shocks in

the short run through changes in Output and Employment - not through changes in Prices.

General Sources of Shocks:

1) Irregular Innovations - significant new products or production methods, such as those associated with computers, the internet, transportation (cars, trains, planes, etc.) can spread rapidly through the economy, driving increases in investment, consumption, output, and employment.

After the Economy has absorbed the innovation, it may slow down or even decline for a period. Because these innovations occur unexpectedly and irregularly, they may contribute to the variability of economic activity

2)  Productivity Changes - when productivity (output per unit of input) suddenly or unexpectedly increases, the economy booms; when productivity unexpectedly decreases, the economy declines. These fluctuations can result from unexpected changes in resource availability, or even in the rate of technological advance.

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3)  Monetary Factors -A nation's bank can shock its economy by unexpectedly creating more money, which often leads to inflation

(almost always, in fact). By contrast printing less money can have

the opposite and trigger an output decline and a price decrease.

4)  Political Events - unexpected political events - such as new wars, peace treaties, terrorist attacks create new opportunities in the economy, or impact it negatively. So, the economy can experience upswings or downswings as a result

5)  Financial Instability- Unexpected financial "bubbles" (where there is rapid asset increase - like the housing bubble of the 90' s and early millennium), or bursts (where there is a rapid asset decrease - like the housing bubble burst in 2007) can easily spill over into the general economy by increasing or decreasing loans or boosting or eroding consumer confidence. These sector events will eventually affect the rest of the economy

Unemployment: The U.S. Bureau of Labor Statistics (BLS) conducts a nationwide, random survey of 60,000 households each month to determine who is employed and not employed. The BLS divides the total U.S. population into three groups:

1)  People under sixteen years of age and institutionalized (mental hospitals or prisons).  Why do you think this is the case?                                                                       ·

2)   Not in Labor Force - composed of adults who are potential workers but are not employed and are not seeking work

3)   The Labor Force - are people who are able and willing to work. Both those who are employed and those who are unemployed - but actively seeking work - are counted as being in the Labor force

So, the Unemployment rate is the percentage of the labor force unemployed.  Figure 29.2 on page 560 is a picture of the labor force in 2018

Note: there are issues or concerns with the unemployment rate in the current way it is counted.

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Concerns:

I) Part-time Workers - the BLS lists all part-time workers as fully employed. In 2009, about 29 million people worked part time as a matter of choice. Another 9 million wanted full time work but

. could not find it

By counting part time workers as fully employed, many critics feel this understates the true unemployment rate

2) Discouraged Workers -you must be actively seeking a job to be counted as unemployed. Anyone without a job not looking for work is classified as "not in the Labor Force"

The concern is that many workers, after being unsuccessful at finding a job, become discouraged and drop out of the labor force. 778,000 people fell into this category in 2009. Again, by not counting these people, critics complain that the unemployment rate is understated.

Types of Unemployment - there are three

I) Frictional Unemployment - ·this refers to those people who are "between jobs". Some are moving voluntarily from one job to another; others have been temporarily laid off and are waiting to be re-hired.

Another point is that, according to the BLS, most workers do not stay in the-unemployed pool exceptionally long historically.  However, I think the current trend is seeing that history change. Many people seeking work have been out of work for several years, and this· trend is growing

2)   Structural Unemployment - has to do with the composition of the labor force, or more specifically, with the kinds of occupations transforming, changing, or moving over time within the economy.

Some occupations, or the demand for certain skills (sewing clothes or working on farms) may decline or disappear from the economy, while demand for other skills, (designing software or maintaining computer systems) will increase. So, structural unemployment results because the composition of the labor force does not respond immediately/completely to the new structure of job opportunities.

Workers who find that their skills or experience are obsolete will remain structurally unemployed until they develop a new set of skills that are marketable.

Geography can play a part as well. For example, the migration of industries from one part of the country to another, or from cities to suburbia can drive structural unemployment as workers either cannot follow the jobs or choose not to. Offshoring of jobs to other countries is another recent example of structural unemployment; in most cases, workers who are displaced in this manner cannot follow the jobs even if they wish to

Note: the key difference between frictional and structural unemployment is that frictionally unemployed workers have marketable skills and either live in areas where jobs exist or can move to where the jobs have migrated to. Structurally unemployed workers find it difficult to obtain new jobs without retraining, additional education or relocating.

3)   Cyclical Unemployment- or "real unemployment" is caused by a decline in total spending, or insufficient demand for goods and services. This occurs in the Recession phase of the Business cycle

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Full Employment-this does not mean that 100% of the labor force is employed. That is because frictional and structural unemployment are unavoidable in a dynamic economy. Full employment thus occurs when there is no cyclical unemployment.

Cost of Unemployment - in economic terms, the basic cost of unemployment is foregone output. When the economy fails to create enough jobs for those who are able and willing to work, potential production of goods and services are irretrievably lost.

GDP Gap and Orkun's Law- macroeconomist Arthur Orkun determined that for every 1 percentage point of unemployment a negative GDP gap of 2% occurs. This is used to calculate the actual loss of output.

Example - in 2009 the unemployment rate was 9.3%. Using Orkun's

· formula this translates into 8.6% loss of potential GDP. In dollars this represents $1,195 billion lost because of the unemployment rate. So, unemployment costs real dollars in our Gross Domestic Product total.

Look at Figure 29.3 on page 564 and Table 29.2 on page 565 chart for further information

Inflation - the problems posed by inflation are more subtle than unemployment. Inflation is a rise in general prices. When this occurs, each dollar will buy fewer goods and services than before.

Consumer Price Index (CPI) compiled by the Bureau of Labor Statistics (BLS) is the main measure of Inflation. It is reported by the government each month and each year. The CPI is how the government adjusts certain social programs, like social security, minimum wage and unemployment insurance, and things like income tax brackets for inflation.

To come up with the number, the government will calculate and record the spending patterns of consumers over a specific period. In rare cases the CPI can drop (where a dollar will purchase more than it did the year before), but this is rare and is called Deflation

Types of Inflation - nearly all prices in an economy are set by supply and demand

I) Demand-pull Inflation - when inflation is rapid and sustained, the cause is always an over issuance of money by the Federal Reserve Central Ban1c (so, people have more money to purchase than they did before). When this occurs, and resources are fully employed in the economy, the business sector cannot respond to excess demand by expanding output.  So, the excess demand bids up the price of the limited output (think about a new toy or electronic device that people want.  In a time of demand-pull inflation, rising prices do not deter them from purchasing the product).

2) Cost-Push Inflation -this occurs on the supply or cost side of the economy.   In times when output and employment are both declining and spending is not excessive, prices rise anyway.

This is caused by so called supply shocks. Specifically, abrupt changes in the cost of raw materials or energy inputs can drive up per unit production costs and thus product prices. A good example was the skyrocketing price of oil during the 1970's. These "oil shocks" drove inflation throughout the entire economy as the cost of producing and transporting almost every product in America's economy rose.

Hyperinflation - incredibly rapid inflation can devastate an economy in terms of real output and unemployment. Because prices rise so quickly, the economic relationship between businesses and consumers is disrupted. Businesses do not know what to charge and consumers do not know what to pay. In this scenario, money ceases to its job as a medium of exchange and can even become worthless within the economy.

Examples of hyperinflation occurred in Germany after the First World War and in Japan after the second. One famous story tells of waiters in Germany changing the prices on a menu several times during the course of lunch.