Unemployment and Inflation

Transcription

1 Unemployment and Inflation By A. V. Vedpuriswar October 15, 2016

2 Inflation This refers to the phenomenon by which the price level rises and money loses value. There are two kinds of inflation: Demand pull Cost push

3 Demand pull inflation Demand pull inflation may be due to factors like: Increase in money supply Increase in government purchases Increase in exports

4 Cost push inflation Cost push inflation may arise because of : Increase in wage rates Increase in prices of raw materials.

5 Why is inflation bad? Unanticipated inflation is bad because it makes the economic environment unpredictable. Gains and losses occur to different players in the economy because of unpredictable changes in the value of money. If the value of money varies unpredictably over time, the quantity of goods and services that money will buy will also fluctuate unpredictably. Resources are also diverted from productive activities to forecasting inflation. Unanticipated inflation leads to : Redistribution of income between borrowers and lenders Too much or too little lending or borrowing

6 CPI Consumer Price Index (CPI) is one of the most frequently used statistics for identifying periods of inflation or deflation. Large rises in CPI during a short period of time typically denote periods of inflation. The U.S. Bureau of Labor Statistics measures two kinds of CPI statistics: CPI for urban wage earners and clerical workers (CPI-W), The chained CPI for all urban consumers (C-CPI-U). Of the two types of CPI, the C-CPI-U is a better representation of the general public, because it accounts for about 87% of the population. The CPI uses a base year and indexes current year prices based on the base year's values.

7 Headline Inflation The raw inflation figure as reported through the Consumer Price Index (CPI) that is released monthly by the Bureau of Labor Statistics. Also known as "top-line inflation". The headline figure is not adjusted for seasonality or for the often-volatile elements of food and energy prices. Inflation is usually quoted on an annualized basis. Comparisons of headline inflation are typically made on a yearover-year basis.

8 Core Inflation While headline inflation tends to get the most attention in the media, core inflation is often considered the more relevant metric to follow. Core inflation removes the CPI components that can exhibit large amounts of volatility from month to month, ie those that can have temporary price shocks. Core inflation usually excludes energy and food products.

9 Hyper inflation Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Price increases are so much out of control that the concept of inflation is meaningless. The most famous example of hyperinflation occurred in Germany between January 1922 and November By some estimates, the average price level increased by a factor of 20 billion!

10 Hyper inflation in Zimbabwe and Venezuela By 2008, hyperinflation in Zimbabwe was so crippling that beggars who were offered billion- Zimbabwe-dollar bills would frown and reject them! Inflation in Venezuela is expected to cross 700% in In early 2016, ten bolívares are officially worth one US dollar. On the black market, the same dollar fetched 1,150 bolívares. 9

11 Stagflation A condition of slow economic growth and relatively high unemployment accompanied by inflation. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries.

12 Deflation Deflation is a decrease in the overall price level. Prolonged periods of deflation can be just as damaging for the economy as sustained inflation. Japan is a good example. See graph below. 11

13 Inflation in India In India, two indices have been used to track inflation, Wholesale Price Index and Consumer Price Index. WPI has been lower than CPI. In fact, WPI has been negative in recent times mainly due to a steep fall in oil prices. 12

14 Inflation in India: Headline and Core CPI 13

15 Inflation in India in CPI Broad groups 14

16 Inflation in India in WPI Broad groups 15

17 Inflation in India : A brief commentary Persistent and elevated levels of inflation, in particular food inflation, were a major concern in India during the period to During this period, the average wholesale price index (WPI) inflation was 8.0% and average inflation based on the consumer price index for industrial workers [CPI (IW)] was 9.7%. CPI (IW)-based food inflation touched double digits. WPI-based food inflation rose to a high of 9.3% during this period. The trend reversed from onwards. India is depends on imports to meet about 80% of its crude oil requirement. Inflation fell because price of the Indian basket of crude oil declined by 46% in April-December The new monthly CPI (combined), with base 2012=100, is now taken as the measure of headline inflation and is tracked by RBI to anchor its monetary policy. 16

18 Unemployment When people in the labour force do not have jobs, we there is unemployment. Labour force or workforce refers to the number of people employed and self-employed plus those unemployed but ready and able to work. Three factors affect the size of the labour force: Population Migration Labour force participation in economic activity. 17

19 Population Birth rates in most industrial countries fell to replacement levels or lower in the 1980s. The population in many industrial economies is ageing rapidly. Without immigration, it may be difficult to keep these economies ticking. On the other hand, developing countries have young populations. This provides them a demographic advantage. But only if the youth are properly educated and well trained, will they be able to find meaningful jobs. Otherwise an expanding working-age population can create serious problems in areas such as housing and job creation. Unemployed youth can also create social unrest.

20 Migration Foreign-born persons account for a significant share of the labour force in America, Germany, Switzerland, Canada, Australia German unification boosted that country's productive potential. Wealthier developing countries, especially oil producers, have large proportions of foreigners in their labour force.

21 Labour Force Participation Participation rates (the labour force as a percentage of the total population) generally increased in the 1980s and 1990s. Earlier retirement for men, especially in France, Finland and the Netherlands, was generally offset by more married women entering the labour force, especially in America, Australia, Britain, New Zealand and Scandinavia. Now concerns are being expressed that labour force participation in many developed countries, both Europe and US is falling. See next slide.

22 Trends in US labour force participation As Barrack Obama explained in The Economist, Oct 8-14, 2016, America has faced a long-term decline in participation among prime-age workers. In 1953, just 3% of prime age men were out of the labour force. Today, it is 12%. In 1999, 23% of prime-age women were out of the labour force. Today, it is 26%. People joining or rejoining the workforce in a strengthening economy have offset ageing and retiring baby-boomers since the end of 2013, stabilising the participation rate but they have not reversed the longer-term adverse trend.

23 The Unemployment rate Usually defined as a percentage of the labour force (the employed plus the unemployed) that does not have jobs. There are national variations : Germany excludes the self-employed from the labour force; Belgium produces two rates expressing unemployment as a percentage of both the total and the insured labour force. By changing the definition, the unemployment rate can be moved up or, down by several percentage points.

24 Types of unemployment Frictional: the result of people entering and leaving the labour force as they search for jobs and find them. Arises because people often spend time on job search or take a break before starting with a new employer. Structural: the result of changes in technology, international competition, etc. Arises due to skill obsolescence. Jobs may be there but without the necessary skills, people will not get these jobs. Cyclical: fluctuates with the business cycle. Increases during a recession and falls during an expansion.

25 Full employment The natural rate of unemployment is that rate at which there is no cyclical unemployment, ie all the unemployment is structural or frictional. Full employment occurs when the unemployment rate equals the natural rate of unemployment. The natural rate of unemployment depends on how well the labour markets are working. Flexible labour markets can bring it down while rigidities in the labour markets can drive it upwards.

26 Job rationing: Example of labour market rigidity Job rationing is the practice of paying employed people a wage that creates an excess supply of labour, a shortage of jobs and increases the natural rate of unemployment. It arises because of : Efficiency wage: The company may pay more to attract and retain talent. Insider interest: Insiders are a strong interest group and would not like outsiders to be paid lower wages. Minimum wage: The government may specify minimum wages.

27 Discussion topic Unemployment rates in Europe have tended to be higher than in the US. Why is this so? ( Pl see next slide.)

28 GDP, Inflation, Unemployment Ref: Economist, Aug 13,

29 Phillips curve (1) In 1958, a New Zealand economist, A.W.H. Phillips proposed that there was a trade-off between inflation and unemployment. The lower the unemployment rate, the higher the rate of inflation. When the labour market is tight, wages rise rapidly. Periods of high wages are correlated with periods of high inflation. So low unemployment rates are correlated with higher inflation. On the other hand, unexpected price increases reduce real wages, increase demand for labor and reduce unemployment. Economies did seem to work like this in the 1950s and 1960s, but then the relationship broke down.

30 US Unemployment and Inflation in the 1960s 29

31 Breakdown in the trade off after the 1970s 30

32 Phillips curve (2) The trade-off along the Phillips curve is based on errors in inflation expectations. But, as the price level rises, workers eventually realize that real wages are falling and demand higher wages. The increase in real wage tends to reverse the drop in the unemployment rate. In the long run, the unemployment rate tends toward a level that is consistent with a stable rate of inflation. This has been dubbed the "natural" rate. 31

33 Natural Rate of Unemployment in the US Source: US Congressional Budget Office 32

34 NAIRU (Non Accelerating inflation rate of unemployment) Now economists use the technical term, the NAIRU, the lowest rate of unemployment at which inflation does not accelerate. This is the lowest rate of unemployment at which the jobs market can be in stable equilibrium. When unemployment is above this rate, demand can potentially be increased to bring it to the natural rate. But attempting to lower it even further will only cause inflation to accelerate.

35 Skepticism about the natural rate From the middle of 1997 through September 2001, the civilian unemployment rate was below 5%. Over that time, the inflation rate remained modest. Continued low inflation in the face of tight labor markets led to some skepticism about the merits of the natural rate theory altogether. Possible explanations include higher productivity, more workers joining the global labour pool and global excess capacity leading to cheap imports. 34

36 The Philips curve in the long run (1) If unemployment falls below the natural rate, the rate of inflation would end up permanently higher after workers raise their expectation of inflation. There would be a new Phillips curve describing the trade-off consistent with that higher expected rate of inflation. The implication of a constantly shifting Phillips curve is that in the long run there is no trade-off. The long-run Phillips curve is vertical at the natural rate. 35

37 The Philips curve in the long run (2) Ref : Brian W. Cashell, Inflation and Unemployment: What is the Connection? 36

38 The Keynesians Keynesians assume slack in the economy. Wages are inflexible downwards. If the demand for labour falls, the result is higher unemployment and not lower wages. The government can lower the rate of unemployment if it is willing to accept a little more inflation. The Keynesians envisage a bigger role for the government and are suspicious about the markets.

39 The Monetarists/Classical School Monetarists such as Milton Friedman argued that the economy if left to itself would move to full employment through a fall in wages. The supposed inflation-unemployment trade-off is in fact a trap. Governments that tolerate higher inflation in the hope of lowering unemployment would find that joblessness will only fall briefly before returning to its previous level. At the same time, inflation would rise and stay high. Unemployment has an equilibrium rate, determined not by the amount of demand but by the structure of the labour market. The monetarists stress the importance of flexible labour markets to keep unemployment low. The monetarists envisage a smaller role for the government and a greater role for the markets. 38

40 Thank You