The Power Of Macroeconomics

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The Power Of Macroeconomics
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Unemployment, Inflation, and Stagflation
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The Purpose Of This Lesson

• Is to examine much more closely three of the most
  important problems in macroeconomics--unemployment
  and inflation, and the combination of these two
  problems known as stagflation.

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Lesson 5 Colander McConnell Samuelson
Schiller Brue Nordhaus 3rd Edition 14th
Edition 16th Edition 8th Edition
Complete Textbook (includes both Micro-and
Macroeconomics) Macroeconomics Text Only
8 (Repeat from 29 (Repeat from 6, 7 (Repeat
14 Lecture One), 16 Lecture Two), 30 from
Lecture One), 16
8 (Repeat from 13 (Repeat from 6, 7
(Repeat 14 Lecture One), 16 Lecture Two),
14 from Lecture One), 16
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Unemployment and Inflation

• These are two of the most important problems in
  macroeconomics, and in most cases,
  macroeconomists can solve at least one of
  them--but only by worsening the other.

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For Example

• Expansionary fiscal or monetary policy can
  usually pull an economy out of a recession--but
  such actions may cause inflation.
• On the other hand, contractionary policies
  typically can be used to fight inflation--but
  only at the cost of more unemployment and
  recession.

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When The Economy Faces Both

• What happens when an economy faces both high
  unemployment and inflation--as many nations did
  during the turbulent 1970s?
• Are traditional Keynesian-style monetary and
  fiscal policies still effective in fighting such
  stagflation?

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Is There A Tradeoff

• We have got to learn more about what makes both
  unemployment and inflation tick.
• In doing so, we are going to learn about one of
  the great debates in macroeconomic theory
• Is there a clear tradeoff between unemployment
  and inflation as advocates of the so-called
  Phillips Curve suggest?
• Or is the Phillips Curve simply a dinosaur
  concept of a failed Keynesianism?

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Keynesianism vs. Monetarism

• We are going to compare and contrast the
  Keynesian and Monetarist views of stagflation and
  then illustrate why the doctrine of Supply Side
  economics emerged in the 1980s as a viable
  political alternative to these two competing
  economic camps.
• Lets review some basic concepts about
  unemployment.

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A President's View

• President Ronald Reagan was once asked what the
  difference between a recession and a depression
  was.
• His answer
• A recession is when your neighbor loses his job.
  A depression is when you lose yours.

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A President's View

• While President Reagans definitions werent
  technically correct from a macroeconomists point
  of view, his sharp wit nonetheless drives home
  the point that losing your job can be one of the
  most traumatic events of your life.

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Three Kinds of Unemployment
Frictional
Structural
Cyclical
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Frictional Unemployment

• The least of the macroeconomists worries.
• It arises because of the incessant movement of
  people between regions and jobs or through
  different stages of their life cycle.

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Frictional Unemployment
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Cyclical Unemployment

• Cyclical unemployment is a much more serious
  problem.
• It occurs when the economy dips into a recession,
  and it is this type of unemployment that
  macroeconomists have historically spent most of
  their time trying to solve.

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Structural Unemployment

• Occurs when there is a mismatch between the
  available jobs and the skills workers have to
  perform them.
• It often results when technological change makes
  someones job obsolete--the highly-skilled glass
  blower thrown out of work by the invention of
  bottle-making machines or the specialized auto
  worker replaced by a robot.

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A Second Source Of Structural Unemployment

• Structural unemployment can result from a
  mismatch between the location of workers and the
  location of job openings.
• In the 1980s when the price of oil plunged, many
  oil field workers in the oil-producing states
  found themselves structurally unemployed when
  widespread layoffs occurred--even though
  unemployment was low in other parts of the
  country.

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This Distinction is Important

• It helps economists diagnose the general health
  of the labor market and craft appropriate policy
  responses.
• In the presence of cyclical unemployment due to
  recession, expansionary fiscal or monetary
  policies may be quite appropriate.
• However, structural unemployment often requires
  more targeted policies such as job retraining.

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Unemployment Rate Since 1900

• Unemployment has averaged between 5 and 6 percent
  over the period.
• The biggest unemployment peak is during the Great
  Depression, when unemployment reached 25 percent
  of the work force.
• Since the Great Depression, fluctuations in the
  rate have decreased significantly.
• However, as recently as 1982, the unemployment
  rate reached almost 10.

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Source U.S. Bureau of Labor Statistics
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Two Important Questions

• What is this unemployment rate we are looking at?
• How is it measured?

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Some Statistics

• Statistics on unemployment and the labor force
  are among the most carefully designed and
  comprehensive economic data the United States
  collects.
• The data are gathered monthly in a procedure
  known as random sampling of the population.
• Each month, about 60,000 households are
  interviewed about their recent work history.

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The Unemployment Rate
Survey of 60,000 Households
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The Unemployment Rate
Unemployed People without Jobs looking for
work
X 100
Unemployment Rate

Labor Force
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The Unemployment Rate
Unemployed 8 Million
?
X 100

Labor Force 130 Million
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The Solution
Unemployed 8 Million
X 100
6.2

Labor Force 130 Million
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• Is this unemployment frictional, structural, or
  cyclical?

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Teenage Unemployment

• Teenage unemployment has a large frictional
  component.
• Teenagers move in and out of the labor force very
  frequently.
• They get jobs quickly and change jobs often.

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Unemployment by Age

• Half the unemployed teenagers are new entrants
  who have never had a paying job before.
• All these factors suggest that teenage
  unemployment is largely frictional.

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• One possible reason is racial discrimination.

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Other Theories

• Another theory holds that a high minimum wage
  tends to drive low-productivity black teenagers
  into unemployment.
• Still another theory advanced by some
  conservative critics of the modern welfare state
  blame high unemployment of blacks on the culture
  of dependency that is nurtured by government
  welfare to the poor.

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Lost Output
____ Average
GDP loss As percent
unemployment (, billion of
rate
1995 GDP
during ()
prices) the period
Great Depression (1930-1939)
18.2 4,400 38.5 Sluggish fifties
(1954-1960) 5.2 70 0.3 Oil and
inflation crises (1975-1984)
7.7 2,100 3.6 Recent Tranquility
(1985-1996) 6.2 120 0.1
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Okuns Law

• In calculating the numbers, this table indirectly
  makes use of a very important concept in
  macroeconomics known as Okuns Law.
• By studying macroeconomic data, he found an
  important relationship between output and
  unemployment, a co-movement as it were.

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Okun's Law

• The graph shows that unemployment changes are
  well predicted by the rate of GDP growth.
• According to Okuns Law, for every 2 percent
  actual GDP falls relative to potential GDP, the
  unemployment rate rises by 1 percentage point.

Sources GDP from Office of Management and the
Budget Historical Tables, Unemployment from
Economic Report of the President.
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A Question

• If GDP begins at 100 percent of its potential and
  falls to 98 percent of potential and if the
  unemployment rate is initially at 6, how will
  that rate change?

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The Answer

• According to Okuns Law, the unemployment rate
  will rise from 6 percent to 7 percent.

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An Historical Example

• In 1979, the unemployment rate was 5.8 percent.
• But over the next three years, actual real GDP
  didnt grow at all as the economy stagnated.
• By contrast, potential GDP grew at 3 percent per
  year, increasing a total of 9 percent over the
  3-year period.
• Can you use Okuns Law now to predict the
  unemployment rate in 1982?

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An Historical Example

• Using Okuns Law, we can predict that a 9 percent
  shortfall in GDP should have led to a rise of 4.5
  percentage points in the unemployment rate.
• Therefore, with an unemployment rate of 5.8
  percent in 1979, Okuns Law would predict a 10.3
  percent unemployment rate by 1982.
• In fact, the actual rate was very close 9.7
  percent.

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Okun's Law and Potential GDP

• Okuns Law implies that actual GDP must grow as
  rapidly as potential GDP just to keep the
  unemployment rate from rising.
• GDP has to keep growing just to keep unemployment
  in the same place.
• If you want to bring the unemployment rate down,
  actual GDP must be growing faster than potential
  GDP.

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End of Part 1
Lecturer Peter Navarro Multimedia Designer Ron
Kahr Female Voice Ashley West Leonard