Economics: Understanding U.S. Unemployment Rate

• Unemployment and inflation are important topics in Economics

U.S. Unemployment Rate (1948–)

• Unemployment rises during recessions.
• Unemployment generally falls during periods of economic expansion.

Unemployment Rate

• The unemployment rate is computed from the Current Population Survey.
• Employment refers to people who did any work for pay or profit during the survey reference week.
• Unemployment refers to people not employed but have actively looked for work in the past 4 weeks.
• The labor force is the sum of employment and unemployment.

Defining Unemployment

• The unemployment rate is the percentage of the labor force without a job.
• Unemployment rate = (Number of unemployed workers / Labor force) × 100
• Labor force participation rate is the percentage of the adult (16+) non-institutionalized civilian population who are working or actively looking for work.
• Labor force participation rate = (Labor force / Population age 16 and older) × 100

Problems with Unemployment Statistics

• Marginally attached workers are nonworking individuals who looked for work in the past 12 months but not in the past 4 weeks and are not counted as employed or unemployed
• Discouraged workers are nonworking individuals who have stopped looking for work in the past 4 weeks due to a belief that there is no prospect of getting a job and they are a subset of marginally attached workers.
• The deeper the recession, the more discouraged workers there are.
• Underemployed workers are people who work part-time because they cannot find full-time jobs.

How Good is the Unemployment Rate?

• The unemployment rate is a useful indicator of how easy or difficult it is to find a job given the current state of the economy.
• The unemployment rate is not perfect since it can understate true unemployment due to discouraged workers and underemployment.
• The unemployment rate does not measure the quality of jobs. Economists also look at:
• Labor force participation rate.
• Number of full-time jobs.
• Average wages.

Three Types of Unemployment

• Frictional unemployment
• Structural unemployment
• Cyclical unemployment

Frictional Unemployment

• Frictional unemployment is unemployment due to the time workers spend in job search.
• Example: Jasmine moved to Florida and needs a few weeks to find a new job.

Structural Unemployment

• Structural unemployment is a persistent surplus of job-seekers in a labor market.
• Structural unemployment occurs when the wage rate is persistently above the equilibrium wage.
• Example: Melanie's employer outsourced programming jobs when she and her coworkers refused pay cuts thus creating unemployment.

Causes of Structural Unemployment

• Structural unemployment happens when the wage rate is higher than the equilibrium wage rate due to:
  • Labor unions
  • Minimum wage
  • Efficiency wages
• Efficiency wages are wages that employers set above the equilibrium rate as an incentive for better employee performance.

Minimum Wage and Unemployment

• The traditional argument is that minimum wage creates low-skilled unemployment and the higher the wage, the more structural unemployment.
• Other research suggests the opposite effect or, at any rate, the minimum wage in the United States is relatively low.

Three Types of Unemployment (Summary)

• Frictional unemployment is unemployment due to the time workers spend in job search.
• Structural unemployment is a persistent surplus of job-seekers in a labor market, occurring when the wage rate is persistently above the equilibrium wage.
• Cyclical unemployment is correlated with the business cycle and is the deviation of the actual rate of unemployment from the natural rate of unemployment.

The Natural Rate of Unemployment

• Frictional and structural unemployment are always present and considered "natural."
• Natural unemployment = frictional unemployment + structural unemployment
• Actual unemployment = natural unemployment + cyclical unemployment

Cyclical Unemployment

• Cyclical unemployment correlates with the business cycle and is the deviation from the natural rate.
• Lower growth is correlated with higher unemployment because when GDP falls, firms lay off workers.
• Example: Melanie was laid off from her programming job due to a slump in investment and her employer will rehire her when business picks up.

Purchasing Power of Wage Bill

• Nominal wage rate: Wage in dollar terms.
• Real wage: The purchasing power of your wage rate.
• Real wage = Wage rate / Price index
• The wage rate (numerator) typically rises over time and so does the denominator (prices of the goods and services)
• If the wage rate rises faster than the price of goods, the real wage rises.
• If the wage rate rises slower than the price of goods, the real wage falls.

Why Inflation Matters

• Inflation affects the purchasing power of income.
• Some people (borrowers or lenders) can gain from inflation, while others (lenders or borrowers) lose.
• Lower inflation is not always better; the policies needed to reduce inflation usually increase unemployment.

Winners and Losers from Inflation

• If inflation differs from predictions, some will win and some will lose.
• Interest rate: the price (as a percentage) that a lender charges to a borrower for the use of savings for one year
• Nominal interest rate: the interest rate expressed in dollar terms
• Real interest rate: the nominal interest rate minus the rate of inflation

Inflation Scenario

• Suppose you borrowed $100 from a bank at 5% nominal interest.
• You repay $105 at the end of the year which implies an inflation rate of 5% during the year.
• Each dollar would lose its purchasing power at 5% due to the inflation rate.
• The $105 you return to the bank has the same purchasing power as $100 a year ago, which means you borrowed $100 from the bank for free in purchasing power terms.
• The real interest rate = 0% (= 5% nominal rate - 5% inflation rate)

Inflation: Historical Example

• Americans who took out mortgages in the early 1970s found their real payments reduced by higher-than-expected inflation.
• By 1983, the purchasing power of a dollar was only 45% of what it had been in 1973.

Inflation Impact Summary

• If the actual inflation rate is higher than expected, borrowers gain at the expense of lenders.
• If the inflation rate is lower than expected, lenders will gain at the expense of borrowers
• Unexpected inflation matters.

Disinflation

• Disinflation: the process of bringing down the inflation rate.
• Inflation after disinflation is still inflation, but disinflation is negative inflation.
• The policies needed to reduce inflation usually cause unemployment.
• During the early 1980s in the US:
• Inflation: 13.5% (1980), 10.4% (1981), 6.2% (1982), 3.2% (1983)
• Unemployment: 7.2% (1980), 7.6% (1981), 9.7% (1982), 9.6% (1983)