Chapter 5: Monitoring Jobs and Inflation • The labor market • Measurement of unemployment, labor force participation, employment-population ratio. • Shortcomings of unemployment rate as measure of labor market performance • Statistics describing U.S. labor market • Prices • Why inflation is a problem • Measuring the price level: the consumer price index • Shortcomings of CPI
Unemployment • Why is unemployment a problem? • Lost production and income • Lost human capital • Measuring unemployment • The Current Population Survey • Monthly survey • Approximately 60,000 households • Used to monitor employment, hours wages • Primary source of data for unemployment rates
Labor market definitions • Civilian Non-institutionalized Working Age Population • Excludes military and institutionalized • Working age is 16+ • Unemployed • Without work but has made specific efforts to find a job within the previous four weeks • Waiting to be called back to a job from which he or she has been laid off • Waiting to start a new job within 30 days
Unemployment as a measure of labor utilization. • Imperfect measure because • Excludes some underutilized • Underemployed • e.g. part-time workers who want full-time work • Discouraged workers • People who want jobs but quit searching due to lack of job opportunities • Some unemployment is “natural” • Even when economy is operating at capacity, there are new entrants who must search for jobs • In 2008, more than 3 million new workers entered the labor force and more than 2.5 million workers retired in U.S. economy.
Sources of Unemployment People become unemployed if they • Lose their jobs and search for another job. • Leave their jobs and search for another job. • Enter or reenter the labor force to search for a job. People end a spell of unemployment if they • Are hired or recalled. • Withdraw from the labor force.
All are counter-cyclical, but job losers is most sensitive to business cycle.
Types of Unemployment • Frictional • unemployment that arises from normal labor market turnover (entry, re-entry, etc.) • Affected by UI generosity, demographics • Structural • unemployment created by changes in technology and foreign competition that change the skills needed to perform jobs or the locations of jobs • Cyclical • Fluctuating unemployment over the business cycle • Temporary loss of jobs associated with a recession
Natural Rate of Unemployment • The unemployment rate when the economy • is at “full employment” • has only frictional and structural unemployment, no cyclical unemployment • Natural unemployment rate in 1980s was thought to be around 6%; thought to be around 5% in 1990s and 2000s. • Decline in natural rate due to changing demographics • Baby boom • Entry of women into labor market
Real GDP and Unemployment • Potential GDP is the quantity of real GDP produced • when the economy is at full employment • When the unemployment rate equals the natural rate • Output Gap = Real GDP – Potential GDP
Inflation • Price level • average of the prices that people pay for all the goods and services that they buy. • Inflation rate • percentage change in the price level between time periods. • Inflation • occurs when the price level is rising persistently. • Deflation • occurs when inflation is negative and prices are falling persistently
Why inflation is a problem • Redistributes income and wealth • Borrowers and lenders • Employers and workers • Taxes that are not indexed for inflation • Diverts resources from production • Inflation forecasting becomes more important • Negotiate shorter contracts more frequently • May lead to “barter” if inflation rises to sufficiently high levels (hyperinflation)
Measuring the price level and inflation • Consumer Price Index (CPI) • measures the average of the prices paid by urban consumers for a “fixed” basket of consumer goods and services. • defined to equal 100 for the reference or base period. • Using 1982-84 as the base year, • the CPI in December 2009 was 216 • prices in December 2009 were 116 percent higher than in 1982-84.
Constructing the CPI • Selecting the basket • Based on Consumer Expenditure Survey of 2001-02 • Basket contains 80,000 goods
Constructing the CPI • The monthly price survey • Every month, BLS employees check the prices of 80,000 goods in 30 metropolitan areas • Calculating the CPI • Find the cost of the CPI basket at base-period prices. • Find the cost of the CPI basket at current-period prices. • CPI in t = Cost of bundle at current prices in t X 100 Cost of bundle at base year prices
Base year = 2008 • CPI in 2008 = (70/70)*100 • =100 • (CPI in base year always equals 100 • CPI in 2009 = (70/50)*100 • =140 • Inflation rate between 2008 & 09 • percentage change in CPI • (140-100)/100 = 40%
Biases in CPI The CPI might overstate the true inflation for four reasons: • New goods bias • Quality change bias • Commodity substitution bias • Outlet substitution bias
Consequences of bias in CPI • Increases government spending too quickly • Social Security, Disability, etc. • Approximately 1/3 of federal spending tied to CPI • Causes tax revenue to rise too slowly • Income tax code is tied to CPI • Creates downward bias in estimate of real earnings growth • Distorts private contracts tied to CPI • Union COLA’s
Other price indexes • CPI for different types of consumers • Urban consumers • Urban workers • Different regions, states, metro areas • CPI for specific commodity groups • Core CPI • Excludes food and energy • GDP deflator (covered earlier) • Covers prices of all goods & services produced, not just what consumers purchase.
Adjusting for Inflation: Nominal vs. Real Variables Real Variable in t = Nominal Variable in t X 100 Price Index in t Price index could be CPI or GDP deflator e.g. If Nominal Wage in 2010 is $20 and CPI is 200, Real Wage in 2010 is Real variable • Adjusts nominal values to reflect prices in base year.