Week 2 - Unemployment & Inflation

Chapter 8 – Unemployment and Inflation Outline

• What is the unemployment rate? How is it calculated?

• The significance of the unemployment rate.

• What is the natural rate of unemployment (NRU)? What are the factors that determine the NRU?

• What is inflation?

• The costs of inflation.

• Who gains and who loses when there is inflation?

The Unemployment Rate

• The Canadian Unemployment Rate (1946 - 2015)

  • Statistical data highlighting trends over the years.

Defining and Measuring Unemployment

• Statistics Canada Monthly Survey:

  • Random sample of 56,000 households across Canada.

• Classification of the adult population (age 15+):

  1. Employed (E): Individuals with paid jobs (full-time or part-time).

  2. Unemployed (U): Those without paid jobs, available for work, and have actively searched for work in the past four weeks.

  3. Not in the Labour Force (NILF): Those without paid jobs and not looking for employment.

• Calculations:

  • Labour force (LF) = # of employed + # of unemployed.

Labour-Force Participation Rate (LFPR)

• Formula:LFPR = (Labour force / Adult Population) × 100%

Unemployment Rate (ur)

• Formula:Unemployment Rate = (# of unemployed / Labour force) × 100%

The Significance of the Unemployment Rate

• General Picture of the Labour Market:

  • Reflects how easily individuals can find jobs.

• Regional and Age Disparities:

  • Higher rates among teenagers and in the Atlantic region.

• Overstating Unemployment:

  • Individuals may claim unemployment while not actively seeking jobs.

  • Job searching can be time-consuming.

Understating Unemployment

• Omitted Groups Leading to Underestimation:

  1. Discouraged Workers: Individuals desiring work but have ceased searching.

  2. Marginally Attached Workers: Those awaiting employment yet not actively seeking.

  3. Underemployed Workers: Individuals working below their skill level or part-time.

The Natural Rate of Unemployment (NRU)

• Definition:

  • The normal unemployment rate in an economy over the long term.

  • Reflects neither upward nor downward pressure on inflation.

• Components of NRU:

  • Natural Unemployment = Frictional Unemployment + Structural Unemployment

  • Actual Unemployment = Natural Unemployment + Cyclical Unemployment

• Trends Over Time:

  • Fluctuations in Canada's NRU: 4% in the 1960s, rising to 10% in the late 1980s, dropping to 6% in the mid-2000s, and currently around 7%.

Reasons NRU is Not Constant

• Labour Force Characteristics:

  • A higher proportion of young workers can raise NRU.

• Labour Market Institutions:

  • Strong unions may elevate NRU; employment agencies may decrease it.

• Government Policies:

  • Minimum wage increases can elevate NRU.

  • Generous employment insurance (EI) can prolong job searches.

  • Job training and subsidies help reduce NRU.

Inflation and Deflation

• Definition of Inflation:

  • A rise in overall price levels.

• Inflation Rate Calculation:

  Inflation Rate (πt) = (Price Level in year t - Price Level in year t-1) / Price Level in year t-1 × 100%

The Level of Prices and Its Importance

• Overall Price Level vs. Real Income:

  • It's argued inflation doesn't matter if real income remains steady.

Rate of Change of Price

• Importance of Inflation Rate:

  • Higher inflation rates incur costs to the economy.

  • Types of Costs:

    • Shoe-Leather Costs: Increased transactions due to decreased cash holdings.

    • Menu Costs: Costs incurred by firms adjusting prices.

    • Unit-of-Account Costs: Inflation undermines money's reliability as a measure, complicating economic decisions.

Winners and Losers from Unexpected Inflation

• Fisher Equation:

  • Nominal interest rate (i) = Real interest rate (r) + Inflation Rate (π)

• Impact of Unexpected Inflation:

  • Arbitrary redistribution of wealth occurs; borrowers gain, lenders lose.

Example Calculation of Real Interest Rate

• Calculation Scenario:

  • Nominal interest rate of 6% expected inflation of 2% → expected real interest rate = 4%.

  • If actual inflation is 3.2%, actual real interest rate = 2.8%.

  • Outcomes:

    • Winners: Borrowers

    • Losers: Lenders