The Goals of Macroeconomic Policy Chapter 6 – Part 1 Growth and Low Unemployment

Economic Growth Two ingredients for economic growth 1.Aggregate supply Inputs – Labor (L), machinery, physical capital (K), other resources (land) and entrepreneurship) used to produce outputs : Output - Goods and services produced in economy 2.Aggregate demand The number of goods and services people and businesses want to buy 2

Economic Growth Two tasks of macroeconomic policy 1.Growth policy Intended to make the economy grow faster in the long-run Primarily aimed at aggregate supply 2.Stabilization policy Manage aggregate demand to avoid high unemployment and high inflation short-run stabalization policy 3

The Goal of Economic Growth Small differences in growth rates make enormous difference in the long run GDP per capita annual growth: U.S. 2.3%, U.K. 1.8%, Japan 3% Suppose each country had $1 of output in 1870 U.S. in 1979 = $1 x (1.023) 109 = $11.92 U.K. in 1979 = $1 x (1.018) 109 = $6.99 Japan in 1979 = $1 x (1.03) 109 = $25.07 Labor productivity Amount of output a worker produces in an hour (or a week, or a year) of labor GDP per hour of work 4

The Goal of Economic Growth Productivity growth is almost everything in long run Only rising productivity raises standard of living Small differences in productivity growth rates compound (see previous slide) Enormous difference to society’s prosperity Reduce of poverty Increase leisure time Increases in country’s ability to finance education, public health, environmental improvement, arts... 5

Capacity to Produce: Potential GDP Potential GDP Is the level of real GDP the economy would produce if labor (L) and other resources such as capital (K) were fully employed Labor force Number of people holding or seeking jobs 6

Capacity to Produce: Potential GDP Estimate potential GDP in two steps 1.Count up the available supplies of labor (L), capital (K), and other productive resources 2.Estimate how much output these inputs could produce if they were all fully utilized This transformation is an assessment of the economy’s technology 7

Capacity to Produce: Potential GDP The production function Shows the amount of output that can be produced from given inputs (such as labor and capital) given the available technology Along any production function constant capital and technology Better technology or more capital will shift the production function up and raise potential GDP 8

Figure 1 The Economy’s Production Function 9 0 Labor input (hours) Real GDP (a) Effect of better technology (b) Effect of more capital L0L0 Y0Y0 K M Y1Y1 A 0 Labor input (hours) Real GDP L0L0 Y0Y0 K0K0 K1K1 Y1Y1 A B B GDP = Hours of work x Output per hour = Hours of work x Labor productivity

Growth Rate of Potential GDP Growth rate of potential GDP depends on Growth rate of labor force Growth rate of capital stock Rate of technical progress Growth rate of potential GDP = Growth rate of labor input + Growth rate of labor productivity U.S Growth of labor input ≈ 1% Growth of labor productivity ≈ 2.6% Growth rate of potential GDP ≈ 3.5% 10

Growth Rate of Actual and Potential GDP Over long periods of time: similar Over short periods of time diverge sharply due to cyclical fluctuations 11

Figure 2 Actual and Potential GDP in U.S. 12

Unemployment Unemployed – Not working and actively seeking a job Three types of unemployment – Frictional – Structural – Cyclical 13

Types of Unemployment Frictional unemployment includes  people who are between jobs  people who are just entering or reentering the labor market Critical point is this is short-term unemployment These people have skills and they will get jobs 14

Types of Unemployment Structural unemployment Skill mismatch between workers’ skills and employers’ requirements Geographic mismatch between workers’ locations and employers’ locations Workers displaced by automation Skills no longer in demand. Unemployed due to structural changes in the economy that eliminate some jobs and create other jobs for which the unemployed do not have required skills. This is a stubborn, long-term problem 15

Types of Unemployment Cyclical unemployment Portion of unemployment attributed to changes in production over the business cycle Rises during recessions Falls during expansion 16

Employment and Unemployment Natural Rate of Unemployment –Sum of Frictional and Structural Full employment is defined as: –Zero cyclical unemployment –Unemployment at full employment is equal to the frictional + structural unemployment –the natural rate of unemployment –2014 estimate: 5.2% - 5.8% Potential output –Level of output the economy could produce if operating at full employment 17

The unemployment rate rises during recessions (shaded) and falls during expansions. Unemployment related to the business cycle is cyclical unemployment U.S. Quarterly Unemployment Rate, Natural rate of Unemployment

The Costs of Unemployment When real GDP is above potential output – Unemployment is below the natural rate – Employment is higher than full- employment When real GDP is below potential output – Unemployment rises above the natural rate and – Employment falls below full-employment rate 19

The Costs of Unemployment Slump –A period during which real GDP is below potential and/or the employment rate is below normal Recession –From end of 2007 through June 2009 Slump –The book states 2008 through the first half of We are still in a “slump” 20

21 Potential GDP Actual GDP Real GDP in 2009 Dollars Cumulative gap between actual and potential GDP From 2008 – 2014 (2009 dollars) roughly $5.5 trillion About four months worth of production at 2014 levels

22 Potential GDP Actual GDP Real GDP in 2009 Dollars The growth in potential GDP has slowed down

The Costs of Unemployment Economic cost  opportunity cost of lost output, output produced is less than the economy’s potential output  which means less Income and less consumption 23

The Costs of Unemployment Broader costs – Psychological and physical effects – Setbacks in achieving important social goals – Burden of unemployment not shared equally among different groups in the population Most heavily: minorities, especially minority youth 24

Unemployment Rate for Various Groups % % July 2015

Counting the Unemployed Census Bureau’s Household Survey – Every month – Survey of 60,000 households across America In the labor force and unemployed when: – Don’t have a job – Actively search for work during the previous four weeks – Includes temporarily laid off, expected to return 26

How the BLS Measures Employment Status 27 Includes part time workers

Counting the Unemployed Labor force – Those people who have a job or are looking for one Unemployment rate – Fraction of the labor force that is without a job 28

Employment Status of the U.S. Population—August

How Unemployment is Measured Computing the unemployment rate for the month of July 2008: Labor force: million Employed: million Unemployed: 8.8 million July  Unemployment rate = 5.7%

How Unemployment is Measured unemployment rate The percentage of the labor force that is unemployed. Computing the unemployment rate for the months of July 2009, July 2011 and July 2015: Labor force: million million million Employed: million million million Unemployed: 14.5 million 13.9 million 8.27 million Unemployment rate 2009 = Unemployment rate 2011 = Unemployment rate 2015 =

Average Duration of Unemployment, 1970–2009 Weeks The Duration of Unemployment Table A-12

Problems in Measuring Unemployment Official measure of unemployment underestimates the extent of unemployment Treatment of involuntary part-time workers – Individuals who would like a full-time job but who are working only part time – are counted as employed and in the LF Treatment of discouraged workers –Individuals who would like a job but have given up searching for one – are counted as not being in the labor force 33

Problems in Measuring Unemployment BLS defines discouraged worker 1. Not working 2. Searched for a job at some point in the last 12 months 3. Currently want a job 4. State that the only reason they are not currently searching for work is their belief that no job is available for them 34

discouraged-worker effect The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force. It lowers the unemployment rate! –Suppose 10 unemployed and 90 employed Unemployment rate = 10/100 = 10% –Suppose 1 of the 10 unemployed becomes discouraged Unemployment rate = 9/99 = 9.09% 35 Problems in Measuring Unemployment

Marginally attached to the labor force – Meet the first three requirements of discouraged workers – But not necessarily the fourth: They can give any reason for not currently searching for work 36

Alternative Measures of Unemployment The Six “U”s –Six different unemployment rates Each labeled with a “U” followed by a number –“U-3”: the official unemployment rate 37

38 The Six “U”s Table A-15

Unemployment Insurance Unemployment insurance Government program that replaces some wages lost by workers who lose their jobs Administered by the states under federal guidelines Average weekly benefit in 2013 was $310, 45% Normally last for 6 months Extended to 99 weeks after Great Recession 39

Unemployment Insurance Purpose of program Limits the severity of recessions by providing additional purchasing power Props up aggregate demand during a recession Payroll taxes and unemployment benefits Spreads the cost of unemployment over the entire population Doesn’t eliminate the basic economic cost Higher unemployment benefits Disincentive to look for job 40

Average Unemployment Rates in Several Countries, 1995–2005, 2007 and Unemployment rate higher in Europe - primarily structural. Higher unemployment benefits, for longer periods of time which reduce incentives to accept jobs or acquire skills. Legal obstacles laying off workers 10.8% 12.7% 7.2% 7.1% 5.2% 8.0% 6.7% 2013

Unemployment rates in the EU compared to Japan and the US 42 europa.eu/statistics_e xplained/index.php/Un employment_statisticshttp://epp.eurostat.ec. europa.eu/statistics_e xplained/index.php/Un employment_statistics

Alternative Measures of Employment Conditions The Employment-Population Ratio –Total employment (from the household survey) divided by the total population over age 16 –Tracks the fraction of the adult population that is working –not affected by job-searching behavior 43

The employment-population ratio often measures labor market conditions more accurately than the unemployment rate. The ratio falls during recessions, such as the deep recession of 2008 and The Employment Population Ratio: 1996–

45 The Employment Population Ratio: 1948–2014

46 The Employment Population Ratio: 1948–2014

47 Labor Force Participation Rate (LF/Pop): 1948–2014

Its Not Just Demographics 48

Labor Force Participation Rate: Overall in Blue Along With age in Red