Question: How can we have high economic growth with high unemployment?

Readers Question: How can the U.S. economy be growing, even at 2%+, when the unemployment rate is so high. The unemployed don’t pay taxes, and obviously can’t spend their earnings.

The US economy may be growing by 2%, but, it is still along way below potential output. It is merely recovering from a deep recession. If unemployment fell, then US output would increase by more.

There are a few reasons why you can have unemployment during a period of economic growth.

Firstly, the US is overcoming a prolonged recession, in which nominal GDP fell considerably (around 6% off the top of my head). If you consider the trend rate of economic growth is around 2.5%, this means output is considerably less than potential. This means that despite recent economic growth, the economy is still operating with plenty of spare capacity, and hence unemployment. It would take several years of above trend rate growth before spare capacity is eliminated.

(The level of spare capacity is important for policy makers. Already some policy makers are worried about future inflationary pressure, but, if unemployment is high and spare capacity considerable, then this is likely to subdue inflationary pressure for a considerable time.)

Lagging Factor

Often we find unemployment is a lagging factor. When a firm first experiences a downturn in the economy, it may try to avoid redundancy (there are various costs involved). Therefore, even though economy contracts unemployment may not rise by much. However, other time, firms hire less workers as they adjust to the decline in the economy. Thus we find even when the economy starts to recover, unemployment either continues to rise or falls very slowly.

A country could have significant unemployment even after several years of economic growth. This unemployment would be classed as the NAIRU (or the natural rate of unemployment). This is basically supply side unemployment such as structural and frictional unemployment.

For example, the economy may be growing rapidly, but, if some unemployed workers have the wrong skills they may be unable to get employment in new expanding sectors of the economy. Also, if unemployment benefits were very generous then this could encourage people to remain unemployed despite job vacancies.

However, the main reason for unemployment in the US, is the depth of the recession they are overcoming.

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