AM - Chapter 4. Unemployment and inflation.pptx

Applied Macroeconomics School of Economics and Business Department of Economics Office 1.24B Prof. D. Manuel J. Ortega Tierra ([email protected]) Academic year 2023-24 4 – Unemployment and inflation INDEX 4.1 – Main variables...

Applied Macroeconomics School of Economics and Business Department of Economics Office 1.24B Prof. D. Manuel J. Ortega Tierra ([email protected]) Academic year 2023-24 4 – Unemployment and inflation INDEX 4.1 – Main variables of the labour market 4.2 – Inflation indicators and business competitiveness 4.3 – Phillips curve 2 4 – Unemployment and inflation 4.1 Main variables of the labour market Importance It is closely related to the general level of activity It affects aggregate demand by determining the ability to pay and the size of the market. It affects business opportunities It involves the receipt of remuneration and provides households with the necessary resources to purchase market goods and services The company is a demander of labour as an indispensable factor of production, which affects productivity The evolution of the labour force and the structure and functioning of the labour market affect the company: costs, revenues and results. Unemployment has costs for business and society: it reduces disposable income, instability, diverts resources to mitigate its effects, obsolescence and demotivation Employment is a basic source of social participation GDP depends on the amount of labour 𝐺𝐷𝑃=𝑁 · 𝐴𝑃 used and its productivity 3 4 – Unemployment and inflation 4.1 Main variables of the labour market Concepts and unemployment Structural unemployment That which persists over time as a consequence of the inadequate economic structure. It can be associated with the trend component of the series Difficult to deduce Cyclical It derives from the cyclical behaviour of the economy unemployment 2:1 ratio between output growth and job Okun’s law creation Seasonal unemployment Derived from certain regularities occurring over time 4 4 – Unemployment and inflation 4.1 Main variables of the labour market To be considered: - Absolute versus percentage changes - Quarterly/monthly changes vs. annual changes - Seasonality  seasonally adjusted series - Comparison with neighbouring countries For this: ratios, not absolute terms 5 4 – Unemployment and inflation 4.1 Main variables of the labour market Labour ratios: - Activity rate: Percentage of the working-age population participating in the labour market 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒 𝑎= 𝑃𝑂𝐵16 − 67 - Unemployment rate: Percentage of the labour force that is not employed 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝑢= 𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒 - Employment rate: Percentage of the working-age population that is employed. It is the best measure of the degree to which the human resources available in the economy are being used to produce 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝑒= 𝑃𝑂𝐵16 − 67 - Temporary employment rate: Percentage of employed with temporary contracts - Part-time employment rate: Percentage of employed with a part-time contract 6 4 – Unemployment and inflation 4.1 Main variables of the labour market Labour market develompent in Spain 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 Tasa de actividad Tasa de paro 7 Source: INE and Estadísticas Históricas de España (A. Carreras, X. Tafunell et al.). Own 4 – Unemployment and inflation 4.1 Main variables of the labour market Unemployment: the situation of members of the labour force who are actively seeking employment under current labour market conditions but are unable to find work because there are insufficient job vacancies Frictional unemployment: the transitory situation in which an unemployed person finds himself while gathering information on available vacancies and searches for the job that best suits his characteristics It is due to frictions in the labour market: lack of information, lack of mobility, etc. It is also referred to as “search unemployment” 8 4 – Unemployment and inflation 4.1 Main variables of the labour market Reducing unemployment is an objective of economic policy because it generates costs: Monetary costs Non-monetary costs on households and individuals Costs to public finances Loss of domestic production Loss of human capital Social costs Political costs 9 4 – Unemployment and inflation 4.1 Main variables of the labour market What do we call full unemployment? To the absence of involuntary unemployment It is therefore compatible with frictional unemployment Seasonal unemployment can also be considered compatible with full employment 10 4 – Unemployment and inflation 4.1 Main variables of the labour market NAIRU Long-term unemployment rate consistent with potential GDP, characterised by no inflationary pressures (a lower unemployment rate would increase demand for goods and inflation) Characteristics : Not an observable variable Not constant over time Not homogeneous by countries It is affected by economic policy (structural features) 11 4 – Unemployment and inflation 4.1 Main variables of the labour market Comparison of Okun’s law between countries It is an empirical relationship 12 4 – Unemployment and inflation 4.1 Main variables of the labour market Is it possible to know with absolute certainty how unemployment is evolving based on economic growth? The answer is no: Depends on the causes of fluctuations (both in growth and unemployment) Depend on households’ and firms’ economic decisions (and expectations) Not a causal relationship The relationship changes over time Importance of the institutional framework 13 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Key concepts Weighted average of the prices of goods General price level and services in an economy Inflation rate Percentage change in the general price level between two consecutive periods 14 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Depending on the value of the inflation rate, we shall have for different situations The general price level of an economy rises, but it does so below a level Price stability set as optimal (usually between 2% and 3%), i.e. “tolerable” because it does not distort economic decisions (savings, investment, employment, …). High inflation A sustained and widespread increase in the price level of a country’s goods and services above a certain rate over some time. For inflation to occur, the rise in the price of some goods must not be offset by a fall in the price of others Deflation A sustained and widespread fall in the price level of goods and services in a country. A deflationary situation is detrimental to consumption, economic growth and income redistribution. Hyperinflation It implies an extremely high inflationary rate (typically around 50%) 15 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness What target will the authorities set? Price level or inflation rate? An inflation rate which, in the euro area, is set at 2%. Why is a positive rate set? The indices we use tend to overstate inflation, and orthodox macroeconomic theory considers inflation to be preferable to deflation 16 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness What elements should be observed to set the optimal rate? It should not distort the allocation of resources It should not harm the competitiveness of the economy It should be compatible with an acceptable level of economic activity and employment generation 17 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Infl ation in spain 35 % 30 % 25 % 20 % 15 % 10 % 5% 0% 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 1 3 5 7 9 1 3 4 4 4 4 4 5 5 5 5 5 6 6 6 6 6 7 7 7 7 7 8 8 8 8 8 9 9 9 9 9 0 0 0 0 0 1 1 1 1 1 2 2 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 -5 % 18 Source: INE and Estadísticas Históricas de España (A. Carreras, X. Tafunell et al.). Own 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Why is price stability important? - Shoe leather cost - Menu costs - Effects on production and employment: · Alteration of the price system (which are the signals given by the market about shortages) · Introduces confusion and uncertainty (makes planning difficult: ↓Inv.) · Alters allocation of resources (favours sectors less open to external competition) 19 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Why is price stability important? (Cont.) - Effects on competitiveness vis-à-vis the external sector - Redistributive effects · Between one company and another (not all sectors alter prices equally easily) · Between businesses and consumers (fours consumption of imported products) · Between creditors and debtors (nominal burden stays the same, but real burden decreases) 20 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Consumer Price Index (CPI) Prices of a series of goods and services chosen and weighted according to their importance in the budget of a representative household. The weighting is established according to the weight that each of the goods or services has in the average consumer expenditure, depending on a year that is taken as a base. Inflation would be equal to the rate of change of the CPI. Monthly periodicity Published after 15 days. High disaggregation Includes prices of imported but not exported produces 21 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Harmonised Index of Consumer Prices (HICP) Like the CPI, but constructed with the same criteria in all European countries, favouring transparency and facilitating the implementation of monetary policy. The rate of change of the HICP is the most frequently used measure of inflation in the EU. Underlying inflation Change in the prices of goods and services in the CPI, but excluding energy goods and unprocessed food. Reflects the structural situation of the country’s economy given the lower volatility. It is also more directly affected by monetary policy. GDP deflator Changes in the prices of all goods and services that make up a country’s GDP. Quarterly and annual frequency, published near the end of the following quarter- 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 𝐺𝐷𝑃 𝑑𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 22 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Which will be used for targeting in the use of monetary policy? The ECB uses the HICP Average HICP growth below but close to 2% 23  4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness HIPC – Spain and the EU 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 1997-01 1998-05 1999-09 2001-01 2002-05 2003-09 2005-01 2006-05 2007-09 2009-01 2010-05 2011-09 2013-01 2014-05 2015-09 2017-01 2018-05 2019-09 2021-01 2022-05 2023-09 -2.0% -4.0% European Union (EU6-1958, EU9-1973, EU10-1981, EU12-1986, EU15-1995, EU25-2004, EU27-2007, EU28-2013, EU27-2020) Spain A positive inflation differential with neighbouring countries implies a loss of price competitiveness for the economy. 24 Source: Eurostat 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness Other general indicators for measuring inflation can also be considered: - Prices paid by farmers - Industrial price index These may differ because they measure different things, with each statistic providing valuable information. We tend to choose the CPI because: - It is held on a monthly basis - Widely used by the public - Published data are not subject to revision - It is produced by a different agency than the one in charge of controlling inflation For all the above reasons: it facilitates communication with the public and makes the monetary authorities’ actions more credible. 25 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness There is a commonly used leading indicator of the CPI: Underlying inflation In Spain it is calculated through IPSEBENE As we have seen above, the usual breakdown of the CPI compared to underlying inflation is as follows: - Unprocessed food - Energy products - Processed food - Non-food non-energy industrial goods Underlying inflation - Services 26 4 – Unemployment and inflation 4.2 Inflation indicators and business competitiveness What is the cause of price growth? “Inflation is always and everywhere a monetary phenomenon” (A Monetary History of the United States, 1867-1960, by Milton Friedman y Anna Schwartz) Even so, it can be affected by real causes - Rightward shifts in aggregate demand (expansionary demand policies and improved expectations) - Leftward shifts in aggregate supply (negative technology shocks, increases in factor prices, reductions in labour supply…) But these will simply produce tensions. Sustained inflation can only occur because of monetary causes 27 4 – Unemployment and inflation 4.3 Phillips curve Pricing by firms depends on costs We assume the following production function: 𝑌 = 𝐴𝑁 Which implies constant labour productivity We can simplify it by choosing the units of production accordingly 𝑌 =𝑁 28 4 – Unemployment and inflation 4.3 Phillips curve What will be the marginal cost? 𝑊 In perfect competition  What if not all markets of goods and services are competitive? margin 29 4 – Unemployment and inflation 4.3 Phillips curve Collective and How are wages determined? individual bargaining Differences between countries Factors that determine wages in each country: 1) Reservation wage 2) Wages depend on labour market situation 30 4 – Unemployment and inflation 4.3 Phillips curve Why would an employer pay above the reservation wage? Negotiation Efficiency wages Depends on how easy ist is for the Productivity gains. company and the employee to find substitutes Type of position, qualifications, market situation… will affect wages All things considered: 𝑒 𝑊 =𝑃 𝐹 ( 𝑢 , 𝑧 ) ¿ 31 4 – Unemployment and inflation 4.3 Phillips curve 𝑒 Let us assume that 𝑃 =𝑃 So: 𝑊 =𝑃 𝐹 ( 𝑢 , 𝑧 ) ¿ Dividing everything by prices: Real wage 𝑊 =𝐹 (𝑢 , 𝑧 ) 𝑃 ¿ Graphically: 0 Unemployment rate 32 4 – Unemployment and inflation 4.3 Phillips curve Back to the price equation 𝑃=( 1+𝑚 ) 𝑊 Let us get the real wage Real wage 𝑊 1 = 𝑃 1+𝑚 Graphically: 0 Unemployment rate 33  4 – Unemployment and inflation 4.3 Phillips curve Considering both equations: 1 𝐹 ( 𝒖𝒏 , 𝑧 )= 1+𝑚 This unemployment rate is called the natural rate of unemployment Alterations? Real wage 0 Unemployment rate 34 4 – Unemployment and inflation 4.3 Phillips curve Let us consider again that wages depend on expected prices. 𝑃=( 1+𝑚 ) 𝑊 𝑒 𝑃=𝑃 ( 1+𝑚 ) 𝐹 ( 𝑢 , 𝑧 ) 𝑒 𝑊 =𝑃 𝐹 ( 𝑢 , 𝑧 ) Specifying F: 𝐹 ( 𝑢 , 𝑧 )=1 − 𝛼𝑢 + 𝑧 35 4 – Unemployment and inflation 4.3 Phillips curve Putting it all together… 𝑒 𝑃=𝑃 ( 1+𝑚 )( 1 − 𝛼𝑢 + 𝑧 ) And we are left with… 𝑒 𝜋=𝜋 + ( 𝑚+ 𝑧 ) − 𝛼 𝑢 And considering dynamic behaviour… 𝑒 𝜋 𝑡 =𝜋 𝑡 + ( 𝑚 + 𝑧 ) − 𝛼 𝑢𝑡 36 4 – Unemployment and inflation 4.3 Phillips curve First versión of the curve: 𝜋 𝑡 =𝜋 + ( 𝑚 + 𝑧 ) − 𝛼 𝑢𝑡 Economic policy consequences? Criticism Milton Friedman and Edmund Phelps At the beginning it worked like this, what happened? 37 4 – Unemployment and inflation 4.3 Phillips curve How are expectations formed? 𝑒 𝜋 𝑡 =( 1 − 𝜃 ) 𝜋 + 𝜃 𝜋 𝑡 − 1 𝜃 rose in the 70s! What happens with different values of 𝜃 in the Phillips equation? 38 4 – Unemployment and inflation 4.3 Phillips curve When 𝜃 is 1 we have the modified Phillips curve (or Phillips curve with expectations, or accelerationist Phillips curve): 𝜋 𝑡 − 𝜋 𝑡 − 1=( 𝑚 + 𝑧 ) − 𝛼 𝑢𝑡 39 4 – Unemployment and inflation 4.3 Phillips curve Let us remember the natural rate of unemployment… The natural rate of unemployment is when prices are equal to expected prices. So this equation… 𝑒 𝜋 𝑡 =𝜋 𝑡 + ( 𝑚 + 𝑧 ) − 𝛼 𝑢𝑡 Will look like this if the unemployment rate is equal to the natural rate: 0= ( 𝑚+ 𝑧 ) − 𝛼 𝑢 𝒏 And clearing... 𝑚+𝑧 𝑢𝑛 = 𝛼 40 4 – Unemployment and inflation 4.3 Phillips curve With these two equations: 𝑒 𝑚+𝑧 𝜋 𝑡 =𝜋 + ( 𝑚 + 𝑧 ) − 𝛼 𝑢𝑡 and 𝑢𝑛 = 𝑡 𝛼 We can get to: 𝑒 𝜋 𝑡 − 𝜋 𝑡 =− 𝛼 ( 𝑢𝑡 − 𝑢𝑛 ) And if the inflation rate of the previous period is a good approximation of the expected one, we shall have: 𝜋 𝑡 − 𝜋 𝑡 − 1=− 𝛼 ( 𝑢𝑡 − 𝑢𝑛 ) = Non-Accelerating Inflation Rate of Unemployment (NAIRU) 41 4 – Unemployment and inflation 4.3 Phillips curve Let us combine IS-LM with the Phillips curve But first, how does Y depend on the unemployment rate? 𝑌 = 𝑁 = 𝐿 (1 − 𝑢) 42 4 – Unemployment and inflation 4.3 Phillips curve So… The Phillips curve can be expressed as follows: 𝛼 𝜋 𝑡 − 𝜋 𝑒𝑡 = ( 𝑌𝑡 − 𝑌𝑛) 𝐿 Now let us assume (of the many ways in which expected inflation can be set) that expected inflation is equal to inflation in the previous period 𝛼 𝜋 𝑡 − 𝜋 𝑡 − 1= (𝑌 𝑡 − 𝑌 𝑛) 𝐿 What does it mean? 43 4 – Unemployment and inflation 4.3 Phillips curve Before we continue, let us look at a new concept: Real interest rate Interest rate expressed in a basket of goods 1+ 𝑖 1+𝑟 ⇒𝑟= ≈ 𝑖 − 𝑒 𝜋 𝑒 1 + 𝜋 So the IS relationship looks like this: 𝑌 =𝐶 ( 𝑌 − 𝑇 ) + 𝐼 ( 𝑌 , 𝑟 ) + 𝐺 44 4 – Unemployment and inflation 4.3 Phillips curve r Let us now consider the IS-LM graph and the Phillips curve we have just calculated, with anchored expectations Natural (or neutral, or wicksellian) interest rate 0 Y 𝜋𝑡 − 𝜋 Why does the CB not directly set the interest rate at the natural level? 0 Political reasons, delays, lack of Y knowledge of potential output 45 4 – Unemployment and inflation 4.3 Phillips curve r What happens if expectations become dynamic due to high inflation A period of recession will be necessary if the central bank is not 0 Y only to stabilise inflation, but also 𝜋𝑡 − 𝜋 𝑡 −1 to reduce it 0 Y 46 4 – Unemployment and inflation 4.3 Phillips curve r What happens in a severely depressed economy? 0 Deflationary spiral (or deflation trap) Y 𝜋𝑡 − 𝜋 𝑡 −1 0 Y 47 4 – Unemployment and inflation 4.3 Phillips curve r Effects of rising energy costs? 0 Real wage, W/P Y 𝜋𝑡 − 𝜋 𝑡 −1 0 Y 0 Unemployment rate, u 48 Fin del tema