26

Business Cycles, Unemployment, and Inflation

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

LO1 The Business Cycle

• Alternating increases and decreases in economic activity over time • Phases of the business cycle • • • • Peak Recession Trough Expansion 26-2

LO1

Peak

The Business Cycle

Peak Peak Trough Trough

Time

26-3

The Business Cycle U.S. Recessions since 1950 Period

1953-54 1957-58 1960-61 1969-70 1973-75 1980 1981-82 1990-91 2001 2007-09

Duration, Months

10 8 10 11 16 6 16 8 8 18

Depth (Decline in Real Output)

-2.6% -3.7

-1.1

-0.2

-3.2

-2.2

-2.9

-1.4

-0.4

-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

26-4

LO1 Causation: A First Glance

• Business cycle fluctuations • • • Economic shocks Prices are “sticky” downwards Economic response entails decreases in output and employment 26-5

LO1 Causation: A First Glance

• Causes of shocks • • • • • Irregular innovation Productivity changes Monetary factors Political events Financial instability • Recession of 2007 26-6

LO1 Cyclical Impact

• • Durable goods affected most • • Capital goods Consumer durables Nondurable consumer goods affected less • • Services Food and clothing 26-7

Total population (307.3 million) Unemployment

Under 16 and/or Institutionalized (71.4 million) Not in labor force (81.7 million) Employed (139.9 million)

Unemployment rate = # of unemployed X 100 labor force Labor force (154.2 million) Unemployment rate = 14,265,000 154,142,000 X 100 = 9.3%

Unemployed (14.3 million) 26-8

LO2

LO2 Unemployment

• Criticisms of unemployment • Involuntary part-time workers counted as if full-time • Discouraged workers are not counted as unemployed 26-9

LO3 Types of Unemployment

• • Frictional unemployment • Individuals searching for jobs or 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 26-10

Definition of Full Employment LO3

• 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 26-11

LO3 Economic Cost of Unemployment

• • GDP Gap • GDP gap = actual GDP – potential GDP • Can be negative or positive Okun’s Law • Every 1% of cyclical unemployment creates a 2% GDP gap 26-12

LO3 Economic Cost of Unemployment Economic Cost of Unemployment

26-13

LO3 Economic Cost of Unemployment

26-14

LO3 Unequal Burdens

• • • • • • Occupation Age Race and ethnicity Gender Education Duration 26-15

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

2007

4.6% 2.1

7.6

2009

9.3% 4.6

19.7

Age: 16-19 African American, 16-19 White, 16-19 Male, 20+ Female, 20+ 15.7

29.4

13.9

4.1

4.0

24.3

39.5

21.8

9.6

7.5

Race and ethnicity: African American Hispanic White 8.3

5.6

4.1

14.8

12.1

8.5

Gender: Women Men Education: ** Less than high school diploma High school diploma only College degree or more Duration: 15 or more weeks

LO3

4.5

4.7

7.1

4.4

2.0

1.5

8.1

10.3

14.6

9.7

4.6

4.7

26-16

Noneconomic Costs LO3

• • • • • • • 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, mental illness Can lead to violent social and political change 26-17

LO3 Global Perspective

26-18

LO2 Inflation

• • General rise in the price level Inflation reduces the “purchasing power” of money • Consumer Price Index (CPI)

CPI = Price of the Most Recent Market Basket in the Particular Year x Price estimate of the Market Basket in 1982-1984 100 207.3 201.6

CPI = x 100 = 2.8% 201.6

26-19

LO2 Inflation Inflation Rates in Five Industrial Nations

26-20

Inflation LO2

26-21

LO3 Types of Inflation

• Demand-Pull inflation • • Excess spending relative to output Central bank issues too much money • Cost-Push inflation • • Due to a rise in per-unit input costs Supply shocks 26-22

LO3 Inflation

• • • Difficult to distinguish inflation types Types differ in sustainability • Demand-pull continues as long as the excess spending continues • Cost-push ends in a recession Core inflation • • Without food and energy goods Focuses on more stable prices 26-23

LO3 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



= Percentage change in nominal income Percentage change in price level

26-24

LO3 Who is Hurt by Inflation?

• • • Fixed-income receivers • Real incomes fall Savers • Value of accumulated savings deteriorates Creditors • Lenders get paid back in “cheaper dollars” 26-25

LO3 Who is Unaffected by Inflation?

• Flexible-income receivers • • • COLAs Social Security recipients Union members • Debtors • Pay back the loan with “cheaper dollars” 26-26

LO3 Anticipated Inflation

• Real interest rate • Rates adjusted for inflation • Nominal interest rate • Rates not adjusted for inflation 26-27

Anticipated Inflation LO3 11% Nominal Interest Rate = 5% Real Interest Rate 6% + Inflation Premium

26-28

LO3 Other Redistribution Issues

• • Deflation Mixed effects • • • Incomes may rise Fixed assets values may fall For fixed-rate mortgages, real debt declines • Arbitrariness 26-29

Does Inflation Affect Output?

LO3

• • Cost-Push inflation • • Reduces real output Redistributes a decreased level of real income Demand-Pull inflation • One view is that zero inflation is best • Another view is that mild inflation is best 26-30

LO3 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 26-31

The Stock Market and the Economy

• • Stock prices changing • • • Wealth effect Investment effect Typical changes lead to weak effects Stock market bubbles • • • Huge unwarranted rises in stock prices Excessive optimism and frenzied buying Can be detrimental to an economy 26-32