Chapter 9: Unemployment and In ation Yulei Luo SEF of HKU February 1, 2016
Learning Objectives 1. Measuring the Unemployment Rate, the Labor Force Participation Rate, and the Employment Population Ratio. 2. Types of Unemployment. 3. Explain what factors determine the unemployment rate. 4. Measuring In ation. 5. Using Price Indexes to Adjust for the E ects of In ation. 6. Distinguish between the nominal interest rate and the real interest rate. 7. Does In ation Impose Costs on the Economy?
DOL s Bureau of Labor Statistics (BLS), Household Survey (60,000 households) I Each month, the U.S. Bureau of the Census conducts the Current Population Survey to collect data needed to compute the unemployment rate. I Household members of working age (16+ years old). I Asked about employment during reference week. I Also asked about recent job-search activities.
I Employed people: If they worked during the week before the survey or if they were temporarily away from their job because they were ill, on vacation, on strike, or for other reasons. I Unemployed people: If they did not work in the previous week, but were available for work and had actively looked for work at some time during the previous four weeks. I Labor force: The sum of employed and unemployed workers in the economy. I Unemployment rate: The percentage of the labor force that is unemployed. I Discouraged workers: People who are available for work, but who have not looked for a job during the previous four weeks because they believe no jobs are available for them.
August 913 Civilian Working-Age Population Discouraged workers: People who are available for work, but have not looked for a job during the previous four weeks because they believe no jobs are available for them. Pearson Education Limited 2015 Figure 9.1 The employment status of the civilian working-age population, August 2013 7 of 53
Unemployment Rate Based on the CPS estimates, we calculate several important macroeconomic indicators. The most-watched is the unemployment rate: Number of unemployed Labor force 100 = 11.3 million 155.5 million Unemployment rate 100 = 7.3% This most-common measure of unemployment is known formally as BLS series U-3. Figure 9.1 The employment status of the civilian working-age population, August 2013 Pearson Education Limited 2015 8 of 53
Labor Force Participation and Employment-Population Also important are the labor force participation rate (the percentage of the working-age population in the labor force) Labor force Working - age population 155.9 million 245.9 million 100 = Labor force participation rate 100 = 63.2% and the employment-population ratio (the percentage of the workingage population that is employed): Employment Working - age population 144.2 million 100 = Employment- population ratio 100 = 58.6% Figure 9.1 The employment status of 245.9 million the civilian working-age population, August 2013 Pearson Education Limited 2015 9 of 53
The Household Survey I BLS classi es people who do not have a job and who are not actively looking for a job as not in the labor force. I On a Friday early in each month the US DOL reports its estimate of the previous month s unemployment rate. It will a ect investors views on the health of the economy. I The unemployment rate measures the percentage of the labor force that is unemployed: Unemployment rate = Number of unemployed Labor force I The labor force participation rate measures the percentage of the working-age population that is in the labor force: Labor force participation rate = (1) Labor force Working-age population (2)
An example: What happens if you include the military? I People on active military service are not included in the employment, labor force, or working-age population totals compiled in the BLS survey. I Suppose now people in the military were included in these statistics, what happens to the unemployment rate and the labor participation rate? I We can use expressions (1) and (2) to answer these questions.
Problems with measuring the unemployment rate I Although the BLS reports the unemployment rate measured to the tenth of a percentage point, it is not a perfect measure of the current state of joblessness in the economy. I Understate the degree of jobless: di cult to distinguish between the unemployed and people who are not in labor force. E.g., in recession an increase in discouraged workers is not counted as unemployed as more people stop actively looking for a job then. In addition, part-time workers who look for full-time are counted as employed. I Overstate: BLS doesn t verify the responses of interviewees. Some people who claim to be unemployed and actively looking for work may not be actively looking. May claim not to be working to evade taxes or keep criminal activity unnoticed. I The UER provides some useful information about the employment situation in the country, but it is far from an exact measure of joblessness in the economy.
Alternative Measures of Unemployment: U-6 Some people suggest that we should include discouraged workers and underemployed workers in the unemployment statistics, to create a broader measure of unemployment. The BLS measures this, calling it BLS series U-6. Pearson Education Limited 2015 Figure 9.2 The official unemployment rate and a broad measure of the unemployment rate, 1996-2013 11 of 53
Trends in Labor Force Participation The labor force participation rate of adult men has declined gradually since 1948 but it has increased significantly for adult women, making the overall rate higher today than it was then. Figure 9.3 Trends in the labor force: participation rates of adult men and women since 1948 Pearson Education Limited 2015 12 of 53
Making the Connection Is Falling Labor Force Participation Bad? Politicians often like to point to a falling labor force participation rate as a strongly negative sign for the economy. Is this necessarily true? The two major reasons why the LFPR for men has fallen over the last several decades are: Men have been going to school for longer and retiring earlier than before (why?) Increases in Social Security Disability Insurance availability have allowed people with disabilities to stop work Whether these are good or bad is a value judgment. Pearson Education Limited 2015 13 of 53
Unemployment Rates for Different Groups Unemployment rates vary by ethnic group and by education level. These two observations are statistically related. Figure 9.4 Unemployment rates in the United States, August 2013 Pearson Education Limited 2015 14 of 53
How Long Are People Typically Unemployed? Long periods of unemployment are bad for workers, as their skills decay and they risk becoming discouraged and depressed. During the Great Depression of the 1930s, some people were unemployed for years at a time. Since World War II, average lengths of unemployment have been relatively low; but that changed dramatically with the 2007-2009 recession. Pearson Education Limited 2015 15 of 53
How Long Are People Typically Unemployed? I During the Great Depression of the 1930s, some people were unemployed for years at a time. I In the modern U.S. economy, the typical unemployed person stays unemployed for a relatively brief period of time. I In April 2007 which was during a period of economic expansion 82% of the people who were unemployed had been unemployed for less than six months. I In September 2011, after the end of the 2007 2009 recession, but during a time when the economy was growing slowly, only 55% of the unemployed had been jobless for less than six months. I The average period of unemployment was only 17 weeks in April 2007 but was 41 weeks in September 2011. I The severity of unemployment during and after the 2007 2009 recession was a sharp break from the normal U.S. experience.
Making the Connection The Employment Situation Following the 2007-2009 Recession The fall of the employment population ratio may give an even better indication of how weak the U.S. labor market was during and after the 2007 2009 recession. Explaining these changes is a top priority for labor economists. Pearson Education Limited 2015 16 of 53
The Establishment Survey: Another Measure of Employment I In addition to the household survey, the BLS uses the establishment survey, sometimes called the payroll survey, to measure total employment in the economy (300,000 establishments). I The establishment survey provides information on the total number of persons who are employed and on a company payroll. I The establishment survey has the following four drawbacks: I I I I It does not provide information on the number of self-employed persons because they are not on a company payroll. It may fail to count some persons employed at newly opened rms that are not included in the survey. It provides no information on unemployment. Its initial employment values can be signi cantly revised as data from additional establishments become available.
Comparing the Household and Establishment Surveys The table below gives the data from the July and August 2013 household and establishment surveys: Household Survey Even if all surveys are truthfully and accurately answered, we do not expect the numbers to be identical between the two surveys: Different groups are measured Table 9.1 All surveys have measurement errors Establishment Survey July August Change July August Change Employed 144,285,000 144,170,000 115,000 135,964,000 136,133,000 169,000 Unemployed 11,514,000 11,316,000 198,000 Labor force 155,798,000 155,486,000 312,000 Unemployment rate 7.4% 7.3% 0.1% Household and establishment survey data for July and August 2013 But we get a more complete picture by considering both surveys. Pearson Education Limited 2015 18 of 53
Revisions to Employment Numbers Over time, the BLS adjusts its estimates of employment and unemployment for previous months. Revisions sometimes take place years later. The large negative revisions were because the BLS underestimated the severity of the 2007-2009 recession. Pearson Education Limited 2015 Figure 9.5 Revisions to employment changes, as reported in the establishment survey 19 of 53
Job Creation and Destruction Number of Jobs Establishments Creating Jobs Existing establishments 5,752,000 New establishments 1,299,000 Establishments Eliminating Jobs Existing establishments 5,180,000 Closing establishments 1,203,000 Jobs are continually being created and destroyed in the U.S. economy. In 2012, about 27.8 million jobs were created, while about 25.5 million jobs were destroyed. This is a natural and normal process for the economy. The table shows jobs created and destroyed over a three-month period from September to December 2012. Table 9.2 Establishments creating and eliminating jobs, September- December 2012 Pearson Education Limited 2015 20 of 53
U.S. Annual Unemployment Rate over Time Unemployment rates rise when the economy is faltering, and fall when the economy is doing well. But they never fall to zero. To understand why, we will examine the types of unemployment. Pearson Education Limited 2015 Figure 9.6 The annual unemployment rate in the United States, 1950-2012 22 of 53
Frictional Unemployment and Job Search I Most workers spend at least some time engaging in job search, just as most rms spend time searching for a new person to ll a job opening. I Frictional unemployment: Short-term unemployment that arises from the process of matching workers with jobs. I I Frictional unemployment occurs mostly because of job search: entering or re-entering the labor force, or being between jobs. It also occurs because of seasonal unemployment: some jobs uctuate in availability due to seasonal demand, like ski-instructor or farm-work. I Seasonal unemployment refers to unemployment due to factors such as weather, variations in tourism, and other calendar-related events.
I Because seasonal unemployment can make the unemployment rate seem arti cially high during some months and arti cially low during other months, the BLS reports two unemployment rates each month one that is seasonally adjusted and one that is not. I Some frictional unemployment actually increases economic e ciency by allowing for better job matches. I Structural Unemployment: Unemployment that arises from a persistent mismatch between the skills and attributes of workers and the requirements of jobs. I Structural unemployment is associated with longer unemployment spells. Workers who are structurally unemployed may require retraining in order to obtain modern jobs.
I Cyclical Unemployment: Unemployment caused by a business cycle recession. I In normal recoveries after a recession, unemployment due to cyclical factors will fall. I When the economy moves into recession, many rms nd their sales falling and cut back on production. As production falls, they start laying o workers. I Full employment: When the only remaining unemployment is structural and frictional unemployment. I The uctuations around this normal rate are mainly due to the changes in the level of cyclical unemployment. I Natural rate of unemployment (NRU): The normal rate of unemployment, consisting of structural unemployment plus frictional unemployment. I In the US, most economists estimate the rate to be around 5%. I The NRU is also sometimes called the full-employment rate of unemployment.
Making the Connection How Should We Categorize Unemployment at Caterpillar? In 2013, Caterpillar announced layoffs at its South Milwaukee plant. Did this increase frictional, structural, or cyclical unemployment? This is generally a hard question to answer; we need to look closely at this specific plant: The South Milwaukee plant manufactured mining equipment. Prices for mining products were in decline, decreasing demand for Caterpillar s mining machinery. But sales of other equipment remained strong. The laid-off workers were likely specialists at making mining equipment; so they are probably structurally unemployed. Pearson Education Limited 2015 27 of 53
Government Policies and the Unemployment Rate I Governments often attempt to directly in uence unemployment. I I Example: The government s Trade Adjustment Assistance program o ers training to workers whose rms laid them o as a result of competition from foreign rms. This would reduce structural unemployment. Other policies try to reduce frictional unemployment: by subsidizing new hires. I However some other government policies probably increase unemployment: Unemployment insurance and Minimum wage laws. I Unemployment Insurance and Other Payments to the Unemployed: The opportunity cost of continuing to search for a job is the salary you are giving up at the job you could have taken.
I (Conti.) In the U.S. and most other industrial countries, the unemployed are eligible for unemployment insurance (UI) payments from the government, which help the unemployed maintain their income and spending, lessening the personal hardship of being unemployed and also helping to reduce the severity of recessions. I In the US, UI and other payments to the unemployed are equal to about half of the average wage. I UI helps the unemployed maintain their income and spending, which lessens the personal hardship of being unemployed and also helps reduce the severity of recessions. I I Advantages: UI helps the unemployed maintain their income and spending, which lessens the personal impact of unemployment and also helps reduce the severity of recessions. Disadvantages: The unemployed can spend more time searching for better jobs because they receive these UI payments and then increase the unemployment rate in the economy.
Minimum Wage Laws I In 1938, the U.S. federal government enacted a national minimum wage law. I The current level of MW in the U.S. is $7.25 per hour (At rst, it is $0.25 per hour. After in ation-adjusted, it becomes $4.15 per hour). In November 2010, legislators of the Hong Kong Government agreed to set a minimum wage level of HK$28 ($4.70). I If the MW is set above the market wage determined by the demand and supply of labor, labor supply is greater than labor demand. Some unemployed workers would have been employed if there were no minimum wage. Consequently, the unemployment rate will be higher than it would be without a minimum wage. I Economists agree that the current minimum wage is above the market wage for some workers, but they disagree on the amount of unemployment that has resulted.
Labor Unions I Organizations of workers that bargain with employers for higher wages and better working conditions for their members. I In unionized industries (automobiles, steel, and telecom.), the wage is usually above what otherwise would be the market wage. This above-market wage leads to fewer workers hired in those industries. I But the e ect of the overall unemployment rate is minor because only 9% of workers are unionized.
E ciency Wages I A higher-than-market wage paid by a rm to increase worker productivity. I The reason is that in many business situations, it is di cult to monitor workers. (workers can hidden their activities.) Hence, many rms must rely on workers being motivated enough to work hard. I By paying a wage above the market wage, the rm raises the costs to workers of losing their jobs. I Minimum wage laws, unions, and e ciency wages can cause economies to experience some unemployment even when cyclical unemployment is zero.
Measuring In ation I The prices of most goods and services rise over time. As a result, the cost of living rises. E.g., in 1914, Ford s $5-a-day wage is extremely high, today it is only the level of minimum wage. I Price level: A measure of the average prices of goods and services in the economy. I In ation rate: The percentage increase in the price level from one year to the next. p t π t+1 = p t+1, p t where p t is the price level at time t and π t is the in ation rate at time t.
I (Cont.) Measuring the price level: The GDP de ator is a broadest measure because it includes the price of every nal good and service. I But it is too broad for some purposes. E.g., if we need to know the impact of in ation on the typical household, it is misleading. I The consumer price index (CPI) is a better measure for the cost of living of the typical urban family with four.
The Consumer Price Index (CPI) I One year is chosen as the base year, and the value of the CPI is set to 100 for that year. I In any other year, the CPI is equal to the ratio of the dollar amount necessary to buy the market basket of goods in that year divided by the dollar amount necessary to buy the same market basket in the based year, multiplied by 100. I CPI is also called the cost-of-living index.
Consumer Price Index The consumer price index is a measure of the average change over time in the prices a typical urban family of four pays for the goods and services they purchase. The chart shows the composition of the basket of goods used to create the CPI. This basket of goods derives from a survey of 14,000 households by the BLS. Figure 9.7 The CPI market basket, December 2012 Pearson Education Limited 2015 36 of 53
A Simple CPI Calculation Base Year (1999) 2014 2015 Product Quantity Price Expenditures Price Expenditures (on base-year quantities) Price Expenditures (on base-year quantities) Eye examinations 1 $50.00 $50.00 $100.00 $100.00 $85.00 $85.00 Pizzas 20 10.00 200.00 15.00 300.00 14.00 280.00 Books 20 25.00 500.00 25.00 500.00 27.50 550.00 TOTAL $750.00 $900.00 $915.00 The table above gives the information we need to create the CPI in 2014 and 2015, using the basket of goods from 1999. Formula Applied to 2014 Applied to 2015 Expenditures in the current year Expenditures in the base year CPI = 100 $900 $750 100 = 120 $915 $750 100 = 122 Pearson Education Limited 2015 38 of 53
A Simple CPI Calculation continued Formula Applied to 2014 Applied to 2015 Expenditures in the current year Expenditures in the base year CPI = 100 $900 $750 100 = 120 $915 $750 100 = 122 Based on these data, the inflation rate from 2014 to 2015 is the percentage change in the CPI: 122 120 120 100 = 1.7% Since the CPI measures consumer prices, it is often referred to as the cost-of-living index. CPI-inflation is sometimes used to generate fair increases in wages for workers, and government benefits. Pearson Education Limited 2015 39 of 53
Using Price Indexes to Adjust Prices Suppose your mother received a salary of $25,000 in 1987. This would have bought much more than a salary of $25,000 in 2012. We can use the CPI to estimate the purchasing power of that $25,000 in 2012 dollars: Value in 2012 dollars = CPI in 2012 Value in 1987 dollars CPI in 1987 230 = $ 25,000 $50,000 114 So $25,000 in 1987 would have bought about as much as $50,000 in 2012. Pearson Education Limited 2015 43 of 53
Nominal and Real Values The current standard base year for the CPI is an average of 1982-1984 prices. Values like wages in current-year dollars are called nominal variables. When we adjust them for inflation, by dividing by the current year s price index and multiplying by 100, we convert them to real variables. Example: Caterpillar employees signed a contract freezing wages until 2018. How much less will their wages be worth then? Year Nominal Average Hourly Earnings CPI (1982 1984 = 100) Real Average Hourly Earnings (1982 1984 dollars) 2013 $27.00 233 $11.59 2018 27.00 260 (est) 10.38 If the CPI rises to 260, then Caterpillar employees will receive a real wage decrease of: $10.38 $11.59 100 = 10.4% $11.59 Pearson Education Limited 2015 44 of 53
Is the CPI Accurate? I CPI is the most widely used measure of in ation, so it is important that it be as accurate as possible. 4 factors make it overstate the true in ation rate (CPI overstates true in ation by 0.5 to 1 percentage point): 1. Substitution bias: In constructing the CPI, the BLS assumes that consumers purchase the same monthly amount of each product in the market basket, but consumers actually buy fewer of those products that increase most in price. 2. Increase in quality bias: Increases in the prices of the products partly re ect their improved quality and partly are pure in ation. It is di cult to separate the two factors. 3. New product bias: For many years, the BLS updated the market basket of goods used in computing the CPI only every 10 years, which excluded new products introduced between updates. 4. Outlet bias: Because the BLS continued to collect price statistics from traditional full-price retail stores, the CPI did not re ect the prices some consumers actually paid at discount stores and over the Internet.
The Producer Price Index (PPI) I PPI: An average of the prices received by producers of G&S at all stages of the production process. I It is conceptually similar to the CPI, in that it uses a basket of goods, but the goods are those used by producers. I The PPI includes the prices of intermediate goods such as cotton, steel, and raw materials. I If the prices of these goods rise, the cost to rms of producing nal products will rise, which may lead rms to increase the prices of products purchased by consumers. I Changes in PPI can be used to predict future movements in the CPI.
Real versus Nominal Interest Rates I Nominal interest rate: The stated interest rate on a loan. I Real interest rate: The nominal interest rate minus the in ation rate. It provides a better measure of the true cost of borrowing and the true return to lending than does the nominal interest rate. I For low rates of in ation, a convenient approximation for the real interest rate is: Real interest rate = Nominal interest rate - In ation rate I De ation: A decline in the price level, i.e., negative in ation.
I (Cont.) Holding the nominal interest rate constant, the higher the in ation rate, the lower the real interest rate. I E.g., if both of you and the person to whom you lend $1000 expected the in ation rate to be 2%, you both expected the real interest rate to be 4% if the nominal interest rate is 6%. If the actual in ation rate turns out to be 4%, the real rate will be 2%: That s good news for your borrower but bad news for you.
U.S. Nominal and Real Interest Rates The chart shows the interest rate on three-month treasury-bills, a good measure of the nominal interest rate. The real interest rate adjusts them for changes in the CPI. Pearson Education Limited 2015 Figure 9.8 Nominal and real interest rates, 1970-2013 Notice that in 2009, the real interest rate was above the nominal interest rate. This was because the change in the CPI was negative then, indicating a rare deflation, or decrease in the price level. 47 of 53
Does In ation Impose Costs on the Economy? I In ation A ects the Distribution of Income: In ation does not reduce the a ordability of goods and services to the average consumer because an expected in ation rate of 10% will raise the average price of goods and services by 10%, but it will also raise average incomes by 10%. I However, it still imposes costs on the economy. I I It is unlikely that everyone s wages would increase at the same rate. Many people have long-term contracts specifying their wage in nominal terms, for example. Also, nominal assets like cash decrease in value when there is signi cant in ation. If you hold much of your wealth in cash, then in ation causes a signi cant decrease in real wealth for you.
I (Conti.) The extent to which in ation redistributes income depends in part on whether the in ation is anticipated in which case consumers, workers, and rms can see it coming and can prepare for it or unanticipated in which case they do not see it coming and do not prepare for it. I The problem with anticipated In ation: Paper money loses some of its value so that anyone holding paper money will nd that its purchasing power decreasing by the in ation rate. In addition, rms need to reprint their price catalog listing more frequently. I Menu costs The costs to rms of changing prices. I The problem with unanticipated In ation: When the actual in ation rate turns out to be very di erent from the expected in ation rate, some people gain, and other people lose. This outcome seems unfair to most people because they are either winning or losing only because something unanticipated has happened. This apparently unfair redistribution is a key reason why people dislike unanticipated in ation.
What s so Bad about De ation? I What if an economy begins to experience falling prices de ation? I Should falling prices encourage consumers to increase their spending as G&S become less expensive? According to two important de ationary episodes: the U.S. during the 1930s and Japan during the 1990s, the answer is No. The main reason is that many consumers in the face of de ation were waiting for prices to go even lower. I Waiting for falling prices was also a problem for the U.S. housing market in the late 2000s. When housing prices began to decline, many potential buyers postpones purchases in the expectation that prices would continue to fall.
Making the Connection What s So Bad about Falling Prices? Deflation is much more dangerous for an economy than inflation. Why? Suppose you are considering buying a car. You know the car will be cheaper next year, so you delay purchasing. But if everyone does the same, then many purchases are postponed, firms stop producing, people become unemployed, etc. This can create a dangerous downward-spiral, delaying economic recovery. Economists believe this occurred after the Great Depression of the 1930s, and also in Japan in the 1990s. There were concerns that significant periods of deflation might have followed the recession of 2007-2009. but fortunately that did not occur. Pearson Education Limited 2015 52 of 53
Common Misconceptions to Avoid I Many economic indicators like the unemployment rate are only created from sample data, so they are not exact measures of economic well-being. I The BLS does not estimate separately the causes of unemployment; but these are still useful to understand. I The price level compares prices in a given year to those in a base year; in ation represents changes in price levels.