UNEMPLOYMENT AND INFLATION

“There is a short run trade-off between reducing inflation and reducing unemployment.”-Me, on the second day of class

UNEMPLOYMENT

%

•Labor force = # of unemployed + # of employed•To count as “unemployed”, a jobless person must be actively seeking employment, so•To count as “in the labor force”, a person must either have a job or be actively seeking one.

•Therefore, the following types of jobless people do not factor into the unemployment rate at all (not in the numerator or the denominator):•Retired people•Students•Stay-at-home parents•Children (< 16 years old)• Institutionalized people (prison, etc.)

FLAWS IN THE CALCULATION OF UNEMPLOYMENT The unemployment rate (as of Oct. 2 2015, according the Bureau of

Labor Statistics) is: 5.1%This figure may understate the joblessness problem, because:

1. Part-time workers are counted as fully employed (so are not in the 5.1%)

2. “Discouraged workers” want a job but have given up looking (so are not actively seeking, so not considered part of the labor force)

This figure may overstate the joblessness problem, because:

3. The “phantom unemployed” are part of the 5.1%. This includes those who claim to be actively seeking but do not actually want a job.

TYPES OF UNEMPLOYMENT1. Frictional Unemployment: those between jobs or between

school and job. The job opening is out there, but job seeker and employer haven’t

found each other yet. (Also known as “search unemployment” or “wait unemployment”)

What recent developments might help reduce this type of unemployment?

2. Structural Unemployment: those whose skills do not match the available jobs.

Again, job openings exist, but in this case there is a skills mismatch. How can this type of unemployment be reduced? (Sometimes “geographic unemployment” and “seasonal

unemployment” are included here.)

3. Cyclical Unemployment: caused by a downturn in the business cycle (a recession).

No job openings are available.

THE NRU•Frictional and Structural are considered inevitable (and even part of a healthy economy).

•Because Frictional and Structural are unavoidable, “full employment” does NOT mean a 0% unemployment rate.

•Instead, an economy is considered at “full employment” if only Frictional and Structural are present (so Cyclical = 0%).

•Frictional + Structural = The “Natural Rate of Unemployment” (the NRU)•AKA the “Full Employment Level of Unemployment”• In most developed economies, = 3-5%

THE COSTS OF UNEMPLOYMENT•Human costs: Of course, some humans must cope with not having a job.

•Economic costs: foregone output•When not at NRU (so some cyclical unemployment):

actual GDP < potential GDP (a “GDP gap”)•Producing at a point inside of the economy’s PPC

•Okun’s Law: For every 1% cyclical unemployment, a 2% GDP gap.

A SAMPLE PROBLEM Suppose:

NRU = 4%

Frictional unemployment= 3%

Actual unemployment = 9%

How much is:

Frictional + Structural?

Structural?

Cyclical?

GDP gap?

INFLATION: SOME DEFINITIONS•A general rise in the level of prices.

•The purchasing power of money decreases.

•The percent change in the Price Index:

x 100%

A healthy rate of inflation: 2-5%

(Our Federal Reserve targets 2%)

“Hyperinflation”: really high inflation. (Probably worst ever was in Zimbabwe in 2008: annual rate of 89,700,000,000,000,000,000,000%)

HURT AND HELPED BY INFLATION Hurt:

•Savers

•Those on Fixed Incomes (with no COLA, or that must wait to re-negotiate wage contracts)

•Lenders/Creditors

So, lenders will apply the “Fisher Equation”

Helped:

Borrowers/Debtors

𝑖≈𝑟+𝜋

NOMINAL WAGES/INCOME VS. REAL WAGES/INCOME The magic formula (works for everything but interest rates):

For wages/income, use the Consumer Price Index (CPI)

Practice problems?