1

Unemployment and Inflation

• How to measure the unemployment rate?– Labor force and the unemployment

• How to measure the inflation rate?– Real GDP vs. nominal GDP– Real interest rate vs. nominal interest rate

2

Unemployment

• The unemployed are those who are willing and able to work but do not have a job and are actively searching for a job.

• The Bureau of Labor Statistics (BLS) collects monthly survey data to compute the unemployment rate.

3

How the BLS Measures Employment Status

4

Unemployment

• Labor force participation rate (LFPR)

• Unemployment rate =

Population age-Working

ForceLabor LFPR

ForceLabor

Unemployed

5

Problems In Measuring Unemployment

– Treatment of involuntary part-time workers • Some economists have suggested that involuntary part-time

workers should be regarded as partially employed and partially unemployed.

– Treatment of discouraged workers• Individuals who would like to work but, because they feel little

hope of finding a job, have given up searching.

6

Types of Unemployment

– Unemployment can arise for a variety of reasons, each with its own policy implications

– Economists have found it useful to classify unemployment into four different categories

– Frictional unemployment– Seasonal unemployment– Structural unemployment– Cyclical unemployment

7

Frictional Unemployment

• Short-term joblessness (between jobs or new entrants)• Good match between workers and jobs• With better suited jobs, works would be more productive.

8

Seasonal Unemployment

• Joblessness related to changes in weather, tourist patterns, or other seasonal factors.

• So, it is short-term and predictable.• To prevent any misunderstandings, government usually

reports the seasonally-adjusted rate of unemployment.

9

Structural Unemployment

• Joblessness arising from mismatches between workers’ skills and employers’ requirements. – Coal miners, autoworkers, etc.

• Generally a stubborn, long-term problem– Often lasting several years or more

10

Cyclical Unemployment

• Business cycle – fluctuations in real GDP around its long-run trend.

• When the economy goes into a recession and total output falls, the unemployment rate rises.

• Since it arises from conditions in the overall economy, cyclical unemployment is a problem for macroeconomic policy.

11

Full Employment

– A situation where there is no cyclical unemployment

– Natural rate of unemployment• Frictional+Seasonal+Structural• In the U.S., it is between 4.5% and 5%.

12

Price Level and Inflation

• Price level– A measure of average prices of goods and services in the

economy

• Index numbers Series of numbers used to track the change of a variable over

time: crime index, air pollution index Most measures of the price level are reported in the form of an

index

Dow Jones Index, S&P 500, Consumer Price Index

13

Index Numbers

• In general, an index number for any measure is calculated as

100 period base in measure of Value

period current in measure of Valuex

14

Index Numbers

• Create index numbersExample: the number of traffic accidents in Youngstown, Ohio

  Year # of traffic accidents index

2000(base year) 325 100

2004 382 5.117100325

382

2005 411

15

The Consumer Price Index

An index of the cost, through time, of a representative market basket of goods and services purchased by a typical urban family of four.

The market basket does not include goods and services purchased by businesses, government, and foreigners, but include consumer goods and services currently produced in the U.S. as well as used goods and imported goods and services.

An example in the textbook on page 625

16

From Price Index to Inflation Rate

• Changes in price index

– Inflation when price level is rising

– Deflation when price level is falling, or negative inflation

17

Inflation, Nominal and Real Values

• Purchasing power of money – amount of goods and services

• Nominal values – measured at current year price• Real values – measured at the base year price• Translate nominal values into real values using the

formula

100 x index price

value nominal value real

18

Inflation, Nominal and Real Values

• Suppose that from December 2004 to December 2005, your nominal wage rises from $15 to $20 per hour– Are you better off?

• Real wage formula is as follows

100 x yearin that CPI

yearin that wageNominal year any in wageReal

19

Inflation, Nominal and Real Values

An example:

Year CPI Nominal Hourly Wage Real Wage

1983 100 8 8100100

8

1995 150 12 8100150

12

2004 180 15 ?100180

15

2005 200 20 ?

20

Nominal and Real Interest Rate

• Interest rate – the cost of borrowing money, express as a percentage of the amount borrowed.

• Nominal vs. Real interest rate

-ir

21

Redistributive Effect of Inflation

• How does inflation redistribute real income? Inflation hurts those who receive a fixed amount of payment

specified in nominal terms

Example: salary specified in a contract

Inflation benefits those who make a fixed amount of payment specified in nominal terms

Examples: mortgage payment, car loan monthly payment

22

Expected vs. Unexpected Inflation

• Over any period, percentage change in a real value (%Δ Real) is approximately equal to percentage change in associated nominal value (%Δ Nominal) minus the rate of inflation

%ΔReal = %ΔNominal – Rate of Inflation

• If inflation is fully anticipated, and if both parties take it into account, then inflation will not redistribute purchasing power

• When inflation is not correctly anticipated, however, inflation does shift purchasing power from one group to another.

23

Expected vs. Unexpected Inflation

An example: Joe borrows $100 from Mike and promises to pay

back the money plus interest in a year. Mike wants to charge a real return of 3%. Meanwhile, Mike expects the inflation rate to be 3% for the next year and Joe expects it to be 5%. So, Joe happily agrees to pay Mike 6% nominal interest rate. If the actual inflation rate is 4%, how will the purchasing power shift between Joe and Mike?