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09 Business Cycles, Unemployment, and Inflation McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. The Business Cycle • Alternating increases and decreases • LO1 in economic activity over time Phases of the business cycle • Peak • Recession • Trough • Expansion 9-2 The Business Cycle Peak Level of real output Peak Peak Trough Trough Time LO1 9-3 The Business Cycle U.S. Recessions since 1950 Period Duration, Months Depth (Decline in Real Output) 1953-54 10 -2.6% 1957-58 8 -3.7 1960-61 10 -1.1 1969-70 11 -0.2 1973-75 16 -3.2 1980 6 -2.2 1981-82 16 -2.9 1990-91 8 -1.4 2001 8 -0.4 2007-09 18 -3.7 Source: National Bureau of Economic Research, http://www.nber.org and Minneapolis Federal Reserve Bank, http://www.minneapolisfed.org/ Output data are in 2000 dollars LO1 9-4 Cyclical Impact • Durable goods affected most • Capital goods • Consumer durables • Nondurable consumer goods affected less • Services • Food and clothing LO1 9-5 The 16 and older noninstitutionalized population that holds a paying job or is actively seeking work. The Current Population Survey counts all persons as unemployed who, during the week before the monthly survey 1. Had no employment, 2. Were available for work, and either 1. Had made specific efforts to find employment some time during the previous 4 weeks or 2. Were waiting to be recalled to a job from which they had been laid off. Labor force does not include Discouraged Workers People who are available and willing to work but have not made specific efforts to find a job within the previous four weeks. Michael Moore “Roger and me.” The adult population sums: employed, unemployed, and those not in labor force, June 2007 (in millions) Unemployed (6.9) LABOR FORCE (153.1) Employed (146.2) NOT WORKING (85.5) Not in labor force (78.6) Labor force= employed + unemployed Not working = not in the labor force + unemployed Adult population = employed + unemployed + not in the labor force 10 Unemployment Total population (307.3 million) Under 16 and/or Institutionalized (71.4 million) Unemployment rate = # of unemployed X 100 labor force Not in labor force (81.7 million) Unemployment rate = Employed (139.9 million) 14,265,000 X 100 = 9.3% 154,142,000 Labor force (154.2 million) Unemployed (14.3 million) LO2 9-12 No Ordinary Recession The U.S. economy shed a net 8,736,000 nonfarm jobs between Jan. 2008 and Jan. 2010, an average of 364,000 jobs lost per month. The U.S. has gained 5.5 million jobs since February 2010 , an average of 153,000 per month. At this rate, we will reach 2007 employment levels again in December 2014. The labor force as a percent of the adult population. Labor Force Participation Rates, United States 90 80 60 Men Women 16-19 Years 50 40 Year 2011 2008 2005 2002 1999 1996 1993 1990 1987 1984 1981 1978 1975 1972 30 1969 Percent 70 Unemployment Duration Percentage Unemployed for 2010 2000 1983 14 weeks or less 47 77 60 27 weeks or more 39 11 25 Source: www.bls.gov Unemployment • Criticisms of unemployment • Involuntary part-time workers counted as if full-time • Discouraged workers are not counted as unemployed LO2 9-21 Types of Unemployment • Frictional unemployment • Individuals searching for jobs or • • LO3 waiting to take jobs soon Structural unemployment • Occurs due to changes in the structure of the demand for labor Cyclical unemployment • Caused by the recession phase of the business cycle 9-23 Frictional Unemployment Joblessness experienced by people who are between jobs or are just entering (or re-entering) the labor market. I am looking for a job in my field—speech pathology Structural Unemployment Joblessness arising from mismatches between workers’ skills and employers’ requirements or between workers’ locations and employers’ locations. An industrial robot took my job. Cyclical Unemployment Joblessness arising from changes in production over the business cycle I couldn’t find work in 1991 due to slump in home building Definition of Full Employment • Natural Rate of Unemployment (NRU) • Full employment level of unemployment • Can vary over time • Demographic changes • Changing job search methods • Public policy changes • Actual unemployment can be above or fall below the NRU LO3 9-27 Economic Cost of Unemployment • GDP Gap • GDP gap = actual GDP – potential • LO3 GDP • Can be negative or positive Okun’s Law • Every 1% of cyclical unemployment creates a 2% GDP gap 9-28 Economic Cost of Unemployment Economic Cost of Unemployment LO3 9-29 The GDP Gap, United States, 2007-2010, in billions of chained 2005 Dollars Assuming the Natural Rate of Unemployment is 5 percent 14,800 14,400 Recession is shaded 14,000 13,600 13,200 12,800 12,400 07Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1 Year/Quarter Potential GDP GDP Source: Brown’s calculation from BLS and BEA data Unequal Burdens • Occupation • Age • Race and ethnicity • Gender • Education • Duration LO3 9-31 Unequal Burdens Unemployment Rates by Demographic Group: Full Employment Year (2007) and Recession Year (2009)* Unemployment Rate Demographic Group Overall Occupation: Managerial and professional Construction and extraction Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+ Race and ethnicity: African American Hispanic White Gender: Women Men ** Education: Less than high school diploma High school diploma only College degree or more Duration: 15 or more weeks LO3 2007 2009 4.6% 9.3% 2.1 4.6 7.6 19.7 15.7 24.3 29.4 39.5 13.9 21.8 4.1 9.6 4.0 7.5 8.3 14.8 5.6 12.1 4.1 8.5 4.5 8.1 4.7 10.3 7.1 14.6 4.4 9.7 2.0 4.6 1.5 4.7 9-32 Noneconomic Costs • Loss of skills and loss of self-respect • Plummeting morale • Family disintegration • Poverty and reduced hope • Heightened racial and ethnic tensions • Suicide, homicide, fatal heart attacks, • LO3 mental illness Can lead to violent social and political change 9-33 Global Perspective LO3 9-34 The Consumer Price Index (CPI) We use the CPI to measure changes in the cost of living experienced by households. The CPI is the “narrow” price index in that the market basket used to construct it includes items purchased by households. Bureau of Labor Statistics economic assistants check the prices of 80,000 items in 30 metropolitan areas each month. The inflation rate is simply the percentage change in the CPI from one period to the next. 1982-84 is the reference base period The CPI Market Basket The BLS now revises the CPI market basket every 2 years 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2012 29.8 31.8 39.8 55.5 86.3 109.3 133.8 153.5 174.5 196.4 227.67 Source: Bureau of Labor Statistics Inflation • General rise in the price level • Inflation reduces the “purchasing • power” of money Consumer Price Index (CPI) CPI = CPI = LO2 Price of the Most Recent Market Basket in the Particular Year Price estimate of the Market Basket in 1982-1984 207.3 - 201.6 x 100 x 100 = 2.8% 201.6 9-38 Computing the Inflation Rate for 2007 The CPI was equal to 203.30 in December 2006. In December 2007 it was 211.680. P 2007 211.680 203.30 100 4.12% 203.30 Inflation In Selected Countries U.S. Argentina Australia China Pakistan Turkey 2007 Russia 2006 Euro Area Britain Japan 0 2 4 6 Percent Source: The Economist 8 10 12 Inflation Inflation Rates in Five Industrial Nations LO2 9-41 Inflation LO2 9-42 The race to stay ahead of inflation •Inflation erodes the purchasing power of income and sets off a race to stay ahead of the cost of living. •Teachers, fireman, truck drivers, nurses, accountants, plumbers, social security recipients, and others strive to increase their incomes so as not to suffer a decrease in their standard of living. •Some groups do better than others. Machinists Job description: Set up and operate a variety of machine tools to produce precision parts and instruments. Mean CPI Year Annual Wage (1982-84 = 100) 1995 $31,270 152.4 2005 $34,790 196.4 Source: Bureau of Labor Statistics Are machinists better off in 2005? Real Wages 1995 Nominal Wages 1995 $31,270 100 100 $20,518 CPI1995 152.4 Nominal Wages 2005 $34,790 Real Wages 2005 100 100 $17,714 CPI 2005 196.4 COLAs Why are we smiling? Because our social security benefits are indexed to the CPI Why doesn’t Congress index the minimum wage to the CPI? Value of the Federal Minimum Wage Nominal Real Value Value (1982-84) 1938 $0.25 $1.77 1949 0.40 1.68 1955 0.75 2.80 1961 1.15 3.85 1966 1.25 3.86 1974 2.00 4.06 1978 2.65 4.06 1989 3.35 2.70 1996 4.75 3.03 2006 5.15 2.53 2007 5.85 2.76 2010 7.25 3.32 Year Source: U.S. Department of Labor Types of Inflation • Demand-Pull inflation • Excess spending relative to output • Central bank issues too much • LO3 money Cost-Push inflation • Due to a rise in per-unit input costs • Supply shocks 9-48 Who is Hurt by Inflation? • Fixed-income receivers • Real incomes fall • Savers • Value of accumulated savings • LO3 deteriorates Creditors • Lenders get paid back in “cheaper dollars” 9-49 Unexpected inflation redistributes real income from lenders to borrowers •Repayments schedules for most debt contracts are fixed in nominal or money terms—that is, debts are not indexed to inflation. •Inflation erodes the real value of repayments. Savings & Loan institutions lost money on long term mortgages in the70s and 80s. We bought this house in 1957 for $19,000. We financed the house on a 30 year mortgage note at 3.5 percent interest. Can you guess what our monthly payment was? Answer: $85.32 Who is Unaffected by Inflation? • Flexible-income receivers • COLAs • Social Security recipients • Union members • Debtors • Pay back the loan with “cheaper dollars” LO3 9-52 Redistribution Effects of Inflation • Nominal income • Unadjusted for inflation • Real income • Nominal income adjusted for • inflation Anticipated vs. unanticipated income Percentage change in real income LO3 = Percentage change in nominal income Percentage change in price level 9-54 Anticipated Inflation • Real interest rate • Rates adjusted for inflation • Nominal interest rate • Rates not adjusted for inflation LO3 9-55 Anticipated Inflation 6% 11% = + 5% Nominal Interest Rate LO3 Inflation Premium Real Interest Rate 9-56 Other Redistribution Issues • Deflation • Mixed effects • Incomes may rise • Fixed assets values may fall • For fixed-rate mortgages, real debt • LO3 declines Arbitrariness 9-57 Hyperinflation • Extraordinarily rapid inflation • Devastates an economy • Businesses don’t know what to charge • Consumers don’t know what to pay • Money becomes worthless • Zimbabwe’s 14.9 billion percent inflation in 2008 LO3 9-58