Entries Tagged 'unemployment' ↓

Readers Question: how the unemployment and inflation is related to country’s economy

If we take the example of the UK, we can see differing examples of how unemployment and inflation are related to a country’s economy. The key to this question is what causes unemployment and inflation. There are several different factors, but it is important to consider both demand side and supply side factors.

Unemployment and Economic Growth. The most obvious factor is that higher economic growth will reduce unemployment. Since 1992, the UK has experienced a long period of economic growth, causing a fall in demand deficient unemployment. Unemployment in 2007 was just under 1 million. In 2008, the unemployment rate has continued to fall; it is about 4% of the labour force (depending on which method you use.) However, in the recession of 1981 (negative growth) unemployment rose to 3 million. Unemployment also rose to 3million in 1992.

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Since Economics is the ‘Dismal Science‘ it may come as no surprise some economists have developed a term known as the misery index.

The misery index is simply the sum of inflation plus unemployment rate. The higher the combined score, the worse the economic situation.

In the UK, at the moment the misery index is relatively low. Unemployment (claimant count) is 3.4%. CPI inflation 2.2%. This gives a combined misery index of 5.6%. Back in the 1980s the misery index was much higher. In 1981, we had unemployment of about 10% and inflation of about 4%, giving a misery index of 14%. At the height of the Lawson boom, inflation reached 11%, with unemployment still persistently high at around 6%.

A lower misery index requires a reduction in both inflation and unemployment. This can only be achieved by supply side improvements which help increase productivity and reduce both structural unemployment and structural inflation.

The Phillips curve suggests there is a trade off between inflation and unemployment, but this trade off can change. E.g rising oil prices could cause cost push inflation, which shift AS to the left causing both inflation and unemployment. This is known as stagflation.

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A quick look at the difference between UK and US Monetary Policy, in particular, which is the most important objective to target.

This dilemna is important because the UK could be experiencing inflation and lower growth, therefore, the MPC may be tempted to keep interest rates too high in order to target low inflation. By contrast the Fed have an objective of both inflation and full employment. The Fed have cut interest rates very significantly in recent weeks.

Should Low inflation be the Most important objective for Government?

Previous Essays on Full Employment

• Should the Government’s Primary Objective be Low Inflation?
• Should the Primary objective of the Government be Full Employment

Readers Question: Is the fiscal policy effective/the best policy to deal with unemployment?

It is an interesting question, and one that is likely to generate different views from within the ranks of Economists.

To give a very rough overview:

• Keynesians say yes, fiscal policy can be effective in reducing unemployment. In a recession, expansionary fiscal policy will increase AD, causing higher output, leading to the creation of more jobs.
• Classical Economics say no. Fiscal policy will only cause a temporary increase in real output. In the long run, expansionary fiscal policy just causes inflation and does not increase real GDP. Classical economists argue that to reduce unemployment it is necessary to use supply side policies which increase the flexibility of labour markets (e.g. reducing power of trades unions)

 So who is Right?

In a way I find the distinction between Keynesian and Classical economists rather artificial. I believe that under certain circumstances both can be right.

Firstly, I do believe that fiscal policy CAN reduce cyclical unemployment. In a recession, cutting taxes and increasing government spending can increase AD, and this injection into the economy is likley to create jobs.

Note: fiscal policy has many limitations such as:

• crowding out (government borrowing reduces size of private sector)
• Tax cuts may be saved not spent
• Time Lags
• See: Criticism of fiscal policy for more details

However, despite these limitations it can play a role in increasing AD and reducing cyclical unemployment.

Can Fiscal Policy Solve Unemployment?

No, fiscal policy cannot solve supply side unemployment. Continue reading →

(a)What are the causes/consequences of unemployment?
The causes of Unemployment are either Demand Side or Supply Side. (most issues in Economics are due to demand and supply)

Demand side or (Demand deficient unemployment) cccurs in a recession or period of low growth. Because firms produce less they  need less workers. If the US goes into recession you can expect to see unemployment rise quite sharply.
Supply side unemployment can be due to:

• Frictional Unemployment (people looking for work)
• Structural unemployment (mismatch of skills, geographical immobilities e.t.c)
• Real Wage Unemployment (wages above the equilibrium)
• Inflexible Labour Markets.

More on Causes of unemployment here

Consequences of Unemployment

1. Rising Government Borrowing. If unemployment rises, less people will pay income tax therefore the government will receive less tax revenue. However, the government will need to spend more on unemployment benefits. Continue reading →

Amidst all the gloom surrounding global credit markets and house prices, it is easy to forget some of the strengths and developments in the UK economy.

One of the most remarkable features of the UK economy is the sustained reduction in unemployment. Falling from a peak of 3 million in 1992, the official method of unemployment is now only 813,000 – a level not seen since April 1975.

Despite the fall in unemployment wage settlements remain fairly muted, with average pay claims being settled a little above 4%.

However, if unemployment continues to fall labour shortages may push up wages and therefore prices. This would make it more difficult to cut interest rates in 2008

The continued fall in unemployment is mainly due to:

• Long Period of Economic Expansion – economic growth close to long run trend rate of 2.5%. UK has avoided boom and bust economic cycles.
• Fall in structural unemployment. e.g. economic regeneration of formerly depressed areas like the north east and South Wales. Note: at the height of the Lawson boom in the 1980s unemployment was still over 1.5 million. – a legacy of structural unemployment in certain regions.
• Greater difficulty in getting unemployment benefits. E.g. people under 18 are not eligible for benefits because they should be on training schemes.

In this post, I suggested that the UK is underestimating its true level of unemployment

Nevertheless, unemployment is significantly lower than it has been for a long time.

Evaluate the importance of managing aggregate demand to bring about a sustained reduction in the rate of unemployment in the UK economy.

In 1992 Unemployment in the UK rose to 3 million, a lot of this was due to the recession of 1992.

In a recession, demand deficient unemployment will increase. This is because as firms close down they have to lay off workers. Therefore, in this case, it is important for the government to try and boost AD and increase the rate of economic growth. For example, the government could pursue expansionary fiscal policy; e.g – lower taxes and higher government spending. This will lead to an increase in AD and therefore, higher growth and jobs will be created reducing unemployment.

If AD increases too quickly it will cause inflation. Therefore, the growth may be unsustainable and the boom may lead to a bust. In this case the job creation will only be temporary. Therefore, it is important to manage AD, so as to maintain stable, low inflationary growth. This will allow a sustained reduction in unemployment. To a large extent, this is what has happened in the UK since 1992. The MPC has used monetary to enable low inflation and stable growth.
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To what extent do the official UK figures for unemployment accurately reflect economic reality ? (30)

 According to government statistics unemployment in the UK, is under 1 million.

The claimant count for Jobseeker’s Allowance was 835,800 in September 2007

This represents less than 3% of the workforce. This is pretty close to full employment; most economist argue that in a modern economy there will always be some frictional unemployment of perhaps 2-3%. This figure of 3% is calculated using the number of people eligible for Job Seekers Allowance JSA.

However, despite the attractive figures, there are many reasons to suggest that this is an under estimate of unemployment

The JSA excludes many groups of people from claiming unemployment benefit, even though they are actively seeking work. Examples include:

• A husband or wife who’s partner is working and earning above a certain amount. i.e. JSA is means tested depending on a partner’s income. After 6 months it is also means tested depending on savings
• People under 18 are not eligible – in theory they should be on training schemes
• People over 55 are often excluded

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