Download Chapter 10 - McGraw Hill Higher Education

Chapter 10
Economic Fluctuations,
Unemployment, and Inflation
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-1
Chapter Objectives
•
•
•
•
•
•
•
•
Examine the business cycle
Consider various business cycle theories
Show how economic forecasting is done
Measure the GDP gap
Learn how the unemployment rate is computed
Look at the types of unemployment
Construct a consumer price index
Consider the theories of inflation
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-2
GDP in 1992 dollars, 1964-2000
GDP
GDP
0
1960 62
64
66
68
70
72
74
76
78
80
82
84
86
88
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90
92
94
96
98
00
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The Conventional Three-Phase
Business Cycle
Peak
Peak
Peak
Prosperity
Trough
Trough
2005
2010
2015
Year
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10-4
Business Cycle Theories
• Endogenous theories
–
–
–
–
–
Innovation theory
Psychological theory
Inventory cycle theory
Monetary theory
Under-consumption theory
• Exogenous theories
– Sunspot theory
– War theory
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10-5
Business Cycle Forecasting
• The Ten Leading Economic Indicators
– 1. Average workweek of production workers in
manufacturing
– 2. Average initial weekly claims for state
unemployment insurance
– 3. New orders for consumer goods and materials
– 4. Vendors performance (companies receiving
slower deliveries from suppliers)
– 5. New orders for capital goods
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10-6
Business Cycle Forecasting
(Continued)
• The Ten Leading Economic Indicators
–
–
–
–
6. New building permits issued
7. Index of stock prices
8. Money supply
9. Spread between rates on 10-year Treasury bonds
and Federal funds
– 10. Index of consumer expectations
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10-7
The Index of Leading Indicators, 1958-2001
Note that the index has turned down well before recessions begin
and turned upward before recovery set in
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10-8
The GDP Gap, 1945-2000
Potential GDP
GDP gap
Actual
GDP
Potential
GDP
Actual
GDP
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Since potential GDP has exceeded actual GDP for most years since World War II,
we have had a GDP gap. However in some periods, most recently from 1996
through 2000, actual GDP has been greater than potential GDP
The GDP gap is the amount of production by which potential GDP
exceeds actual GDP
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Unemployment
• The problem
– One of the most devastating experiences a
person can have is to be out of work for a
prolonged period
– Discouraged workers are those who have
given up looking for work and have simply
dropped out of the labor force
• The Bureau of Labor Statistics does not count
discouraged workers as part of the labor force
and thus as unemployed
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10-10
Unemployment
• The liberal criticism
– A person who worked one day last month is
counted as employed
– Someone who works part-time but who
wants to work full-time is counted as
employed
– The true unemployment rate is higher than
the official rate
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10-11
Unemployment
• The conservative criticism
– Some just go through the motions of looking
for work to remain eligible for benefits and
are not really looking for work
– Huge numbers of Americans – as well as
illegal immigrants are working in the
underground economy
• These people are employed off the books, do not
report their income, and are not counted as
employed by the bureau of labor statistics
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10-12
Unemployment
• The conservative criticism (continued)
– The percentage of married women in the labor force
has risen from 25 percent in the late 1940s to about
65 percent today (this raises the unemployment rate
in three ways)
• Married women who are reentering the labor force will have to
find jobs; because their husbands are employed they can
shop around for a while
• Their husbands, if unemployed, can also shop around for a
while if their wives are working
• The percentage of married women in the labor force
– The true unemployment rate is lower than the
official rate
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10-13
How Is the Unemployment
Rate Computed?
UR =
Number of Unemployed
Labor Force
Number employed
+ Number unemployed
Labor Force
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10-15
How Is the Unemployment
Rate Computed?
UR =
Number of Unemployed
Labor Force
Number employed
+ Number unemployed
Labor Force
July 2000 Number unemployed = 5,650,000
+ Number employed = 134,749,000
Labor Force = 140,399,000
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-16
How Is the Unemployment
Rate Computed?
Number of Unemployed
UR = -----------------------------------------Labor Force
5,650,000
UR = --------------------------------------140,399,000
Number employed
+ Number unemployed
Labor Force
July 2000 Number unemployed = 5,650,000
+ Number employed = 134,749,000
Labor Force = 140,399,000
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-17
How Is the Unemployment
Rate Computed?
Number of Unemployed
UR = -----------------------------------------Labor Force
5,650,000
UR = --------------------------------------140,399,000
Number employed
+ Number unemployed
Labor Force
July 2000 Number unemployed = 5,650,000
+ Number employed = 134,749,000
UR = .0424245 = 4.2 %
Labor Force = 140,399,000
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-18
When It’s a Recession for Whites,
It’s a Depression for Blacks
• Historically, the unemployment rate for
blacks has been double that of whites
– During the 1981-82 recession the
unemployment rate for black teenagers
topped 50 percent
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-19
When It’s a Recession for Whites,
It’s a Depression for Blacks
– There have been major strides toward
equality of economic opportunity since the
mid-1960s, but these strides have left in their
wake a huge Black (and Hispanic)
underclass
• If you are Black or Hispanic, your chances of
being poor are three times as great
• If your are Black or Hispanic, your chances of
being unemployed are twice as great
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-20
When It’s a Recession for Whites,
It’s a Depression for Blacks
• It appears that two things can be done to
ease the economic burden of minority
groups
– Make greater efforts to end employment
discrimination
– Avoid recessions and keep the
unemployment rate as low as possible
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10-21
The Unemployment Rate, 1948-2000
10
9
8
7
6
5
4
3
2
1
0
1948
1952
1956 1960
1964
1968
1972
1976 1980
1984
1988
1992
1996
2000
Unemployment went up between 1969 and 1982 and went down after that
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10-22
Types of Unemployment
• Frictional unemployment
• Structural unemployment
• Cyclical unemployment
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10-23
Frictional Unemployment
• The frictionally unemployed are people
who are between jobs or just entering or
reentering the labor market
– Usually weeks or months pass before
positions are filled
– At any given time, about 2 or 3 percent of
the labor force is frictionally unemployed
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10-24
Structural Unemployment
• A person who is out of work for a relatively long
period of time, say, a couple of years, is
structurally unemployed. Some examples are
– Steelworkers and coal miners who are out of work
because local steel plants and coal mines have closed
– Clerical workers, typists, inventory control clerks
who have been made obsolete by a computer system
– People who are functionally illiterate and who are
virtually shut out of the labor force
• One in five adult Americans is functionally illiterate
• Our educational system turns out 1 million more functional
illiterates every year
– About 2 to 3 percent of our labor force is always
structurally unemployed
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10-25
Cyclical Unemployment
• Cyclical unemployment is anything above
the sum of frictional and structural
unemployment
– Caused by the ups and downs in our
economy known as the business cycle
• Fluctuations in our unemployment rate
are due to cyclical unemployment
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-26
Natural Unemployment Rate
Most economists estimate the natural unemployment rate
to be 5 or 6 percent. If we take a 5 percent unemployment
rate as our working definition of full employment,
anything above 5 percent would be cyclical unemployment
Frictional
2.5%
(Natural)
+ Structural
2.5%
(Natural)
5.0%
(Full unemployment)
1.7%
(Not natural)
+ Cyclical
Unemployment Rate
6.7%
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-27
Natural Unemployment Rate
• If it is increasingly difficult to find employees,
employers will bid up wage rates, pushing up
the rate of inflation
• Once the unemployment rate falls below its
natural rate, then inflationary wage pressure
emerges
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10-28
Inflation
• Defining inflation
– Generally, we consider inflation to be a
sustained rise in the average price level over
a period of years
• When the overall price level is rising, the prices of some
goods and services are going down [e.g., TV prices in the
1970s and the 1980s, the price of VCRs, and more recently
the price of cellular phones]
– U.S. inflation has been persistent since
World War II
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10-29
The Consumer Price Index
(CPI)
• The CPI, which measures changes in our
cost of living, is reported near the middle
of every month by the Bureau of Labor
Statistics
– The CPI is based on what it cost an average
family to live
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-30
Finding Percentage Change in
the Price Level
Year
CPI
1972
125.3
1982
289.1
By what percentage did the cost of
living rise?
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10-31
Finding Percentage Change in
the Price Level
Year
CPI
1972
125.3
1982
289.1
By what percentage did the cost of
living rise?
Change
Percentage change = ---------------------------- X 100
Original Number
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10-32
Finding Percentage Change in
the Price Level
Year
CPI
1972
125.3
1982
289.1
Original Number
By what percentage did the cost of
living rise?
Change = 163.8
Change
Percentage change = ---------------------------- X 100
Original Number
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-33
Finding Percentage Change in
the Price Level
Year
CPI
1972
125.3
1982
289.1
Original Number
By what percentage did the cost of
living rise?
Change = 163.8
Change
Percentage change = ---------------------------- X 100
Original Number
163.8
Percentage change = ---------------------------X 100
125.3
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-34
Finding Percentage Change in
the Price Level
Year
CPI
1972
125.3
1982
289.1
Original Number
By what percentage did the cost of
living rise?
Change = 163.8
Change
Percentage change = ---------------------------- X 100
Original Number
163.8
Percentage change = ---------------------------- X 100
125.3
Percentage change = 1.307 X 100 = 130.7%
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-35
A Magic Number
The number 100 is magic! It lends itself to
calculating percentage changes. Suppose we want to
find out by what percentage prices have risen since
the base year?
The base year is set at 100.
If the CPI today is 136.4, by what percentage did prices rise
since the base year?
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-37
A Magic Number
The number 100 is magic! It lends itself to
calculating percentage changes.Suppose we want to
find out by what percentage prices have risen since
the base year?
The base year is set at 100.
If the CPI today is 136.4, by what percentage did prices rise
since the base year?
136.4 – 100 = 36.4%
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-38
Annual Percentage Change in the Consumer Price
Index, 1946-2000
20
18
16
14
12
10
8
6
4
2
0
Ð2
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Since World War II we have had two periods of price stability-from
1952 through 1965 and from 1991 to the present
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10-39
Inflation Seems Inevitable
• It appears that it takes a
recession to deflate “inflation”
• Sir Frederick Keith-Ross (1957)
– “Inflation is like sin; every
government denounces it and
every government practices it”
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10-40
Deflation
• Deflation is a decline in the general level
of prices for a period of years
– This is the OPPOSITE of inflation
– This last occurred between 1929 -33
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-41
Deflation
• Deflation is a decline in the general level of
prices for a period of years
– This is the opposite of inflation
– This last occurred between 1929 -33
Year
CPI
1929
17.1
1930
16.7
1931
15.2
1932
13.7
1933
13.0
1934
13.4
General price levels are
declining when the CPI is
decreasing.
General price levels are rising
when the CPI is increasing
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10-42
Disinflation
• Disinflation occurs when the RATE of
inflation declines
Year
CPI
Inflation Rate
1980
82.4
13.5%
1981
90.9
10.3%
1982
96.5
6.2%
1983
99.6
3.2%
1984
103.9
4.3%
1981 -83 the rate of inflation
declined . . . but prices
continued to increase . . .
just at a lower rate!
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10-43
Consumer Price Index (CPI)
The most important measure of inflation is
the Consumer Price Index (CPI)
Cost of livingcy
CPI = --------------------------------X 100
Cost of livingby
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10-44
Anticipated and Unanticipated
Inflation: Who Is Hurt by
Inflation and Who Is Helped?
• Debtors benefit from unanticipated
inflation
– They get to repay their loan in dollars that
are worth less than the dollars they
borrowed
– The biggest debtor and gainer from
unanticipated inflation has been the U.S.
government
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10-46
Anticipated and Unanticipated
Inflation: Who Is Hurt by
Inflation and Who Is Helped?
• Creditors, the people who lend out money, are
hurt by unanticipated inflation
– The ultimate creditors, or lenders, are the people
who put their money in banks, life insurance, or any
other financial instrument paying a fixed rate of
interest
• People who live on fixed incomes, particular
retired people who depend on pensions (except
Social Security) and those who hold long-term
bonds, are hurt by unanticipated inflation
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10-46
Anticipated and Unanticipated
Inflation: Who Is Hurt by
Inflation and Who Is Helped?
• When inflation is fully anticipated there
are no winners and losers
– Creditors have learned to charge enough
interest to take into account, or anticipate,
the rate of inflation over the course of the
loan
• This is tacked onto the regular interest rate that
the lender would charge had no inflation been
expected
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10-47
The Real Rate of Interest
• The real rate of interest is the rate that
would be charged without inflation
Expected Rate of inflation
+ Real Rate of Interest
Nominal Rate of Interest <-------what we pay
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10-48
The Real Rate of Interest
• The real rate of interest is the rate that
would be charged without inflation
Expected Rate of inflation
+ Real Rate of Interest
Nominal Rate of Interest
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6%
5%
11%
10-49
The Real Rate of Interest
• The real rate of interest is the rate that
would be charged without inflation
Expected Rate of inflation
+ Real Rate of Interest
Nominal Rate of Interest
6%
5%
11%
If the nominal interest rate accurately reflects the inflation,
then the inflation has been fully anticipated and no one wins
or loses, except the people who borrow money at the higher
nominal rate of interest
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
10-50
The Real Rate of Interest
• The real rate of interest is the rate that
would be charged without inflation
Expected Rate of inflation
+ Real Rate of Interest
Nominal Rate of Interest
6%
5%
11%
But if the rate of inflation keeps growing – even if it is
correctly anticipated – our economy will be in big trouble
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10-51
Theories of the Causes of
Inflation
• Demand-Pull Inflation
• Cost-Push inflation
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10-52
Demand-Pull Inflation
• When there is excessive demand for
goods and services, we have demand-pull
inflation
– This occurs when people are willing and able
to buy more output than our economy can
produce because our economy is already
operating at full capacity
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10-53
Demand-Pull Inflation
• Demand-pull inflation is often summed
up as “too many dollars chasing too few
goods”
– Just where did all of this money come
from”? Milton Friedman, a Nobel laureate
in economics, suspects the seven governors of
the Federal Reserve System, which controls
the rate of growth of the money supply
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10-54
Cost-Push Inflation
• There are three variants of cost-push
inflation
– The wage-price spiral
– Profit-push inflation
– Supply-side cost shocks
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10-55
Cost-Push Inflation: The WagePrice Spiral
– Wages constitute nearly two-thirds of the
cost of doing business
– Whenever workers receive a significant wage
increase, this increase is passed along to
consumers in the form of higher prices
– Higher prices raise everyone’s cost of living,
engendering further wage increases
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10-56
Cost-Push Inflation: Profit
Push
– Because just a handful of firms dominate
many industries, they have the power to
administer prices rather than accept the
dictates of the market forces of supply and
demand
– To the degree that they are able, these firms
will respond to any rise in cost by passing
them on to their customers
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10-57
Cost-Push Inflation: SupplySide Cost Shocks
– Finally, we have supply-side shocks,
most prominently the oil price shocks
of 1973-74 and 1979
• OPEC nations raised the price of oil
• When the price of oil rises, the cost of making
many other things rise as well
– Cost increases are quickly translated
into price increases
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10-58
Inflation as a Psychological
Process
• If people believe prices will rise, they will act in
a way that keeps prices rising
• To break the back of inflationary psychology,
policymakers need to bring down the rate of
inflation for a sufficiently long period of time
for people to actually expect price stability
• This has happened in the recent past only after
successive recessions have “wrung” inflation
out of the economy
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10-59
Creeping Inflation and
Hyperinflation
• Inflation is a relative term
– Creeping inflation in one country would be
hyperinflation in another
• Once we cross the line between creeping
inflation and hyperinflation—which keeps
shifting—we run into trouble
– It becomes increasingly difficult to conduct normal
economic affairs
– Prices are raised constantly
– It becomes impossible to enter into long-term
contracts
– No one is sure what the government might do
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10-60
Conclusion
• One thing the economy has rarely been able to
attain simultaneously is a low unemployment
rate and stable prices
20
15
10
5
0
1950
1960
1970
1980
1990
2000
The Misery Index, 1948-2000
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10-61