Unemployment Fluctuations, NAIRU, and Policies 1

 We know stuff about unemployment  General idea of what it measures: factor utilization  Employed  Unemployed  Not in labour force  UR = U/(U+E) = U/L  It fluctuates a lot in short run  It does not change considerably in long run  It can be sorted by causes  Frictional  Structural  seasonal  Cyclical 2

 Translation of a relatively constant unemployment rate in the long run:  Population grows  Labour force grows  Growth in employment matches labour force growth  Some jobs are eliminated every year  Some jobs are created every year  Jobs created > jobs eliminated, in most years  Cyclical unemployment mostly mirrors changes in GDP 3

 Consequences of unemployment:  Lost output  Okun’s Law (Okun’s rule of thumb):  1% increase in unemployment = about 2% lost GDP  Unemployment hysteresis  While out of work, one cannot maintain qualification  Short-run unemployment may translate in higher NAIRU or smaller labour force  Personal costs  It stinks to be unemployed 4

 Why does unemployment rate fluctuate?  New Classical theories  There are AD/AS shocks, all the time  Every new equilibrium has a different number of workers  AD/AS model  Labour market model  Lower wage = > some quit = voluntary decision  Even business cycles in general can be viewed this way 5

 Why does unemployment rate fluctuate?  New Keynesian theories  Sticky wages  Long-term relationships  Good will  Contracts  Menu costs  It is COSTLY to change wages  Efficiency wages  Incomes, health, and productivity  Competing for heterogeneous workers  Costly monitoring of effort  Unions  Insiders vs outsiders  There is no distinction between short-run and long run in new classical theories  There is no cyclical unemployment, just NAIRU  New classical: “in the long run, we are all dead” (JM Keynes)  Both groups of theories treat long run same 6

 NAIRU = frictional + structural unemployment rates  Frictional  New entries  Search  Structural  Structure of the economy constantly changes  Technological progress  Increase in incomes  Normal, inferior, and luxury goods/services  International structure of employment constantly changes  Treaties  Policies constantly change  Employment insurance EI  Entrance requirements (into occupations) 7

 Changes in NAIRU  Demography  More young people = more new entries  Changes in demand structure  Unemployment hysteresis  While out of work, one cannot maintain qualification  Short-run unemployment may translate in higher NAIRU or smaller labour force  Globalization  Labour markets  Demand structure  Policies  Employment insurance EI 8

 Stock and flow models  In equilibrium, number of becoming unemployed (per week) = number of finding jobs (per week)  Want to reduce unemployed => change the flows  Reduce the flow to unemployment  Increase the flow to employment  Assist with information about employment opportunities  Subsidize re-training 9 employed unemployed