Unemployment Flashcards
Inflation v unemployment trade off
- Policy makers reduce unemployment at a cost of higher inflation: prices rise over time as more people earn more money
- In bad times, employers can get workers to work at lower wages
Problems (of unemployment
- Reduces consumption, income
- Increase anxiety of losing your job
Concepts
- Employed -> working in a paid job
- Unemployed -> not employed but looking for a job
- Labour force -> all employed plays unemployed persons
- Rate of unemployment -> percentage of the labour force that is unemployed
- Even in bosoms there is unemployment, tends to be stable on average over time
Observations
- The unemployment rate is counter-cyclical (increases in recessions, decreases in booms)
- The long-run average varies a lot from country to country
“Cyclical” v “Natural” unemployment
- Natural rate of unemployment
The “normal” unemployment rate the economy experiences when it is neither in a recession or a boom - Prevails when the economy is neither is boom more recession (a.k.a average rate)
- Never zero: more workers than are employed would like to work
- Varies across countries and economies
- Depends only on structural parameters (i.e., separation & finding rate)
- Cyclical unemployment
The difference the actual and the natural rate (difference in cycles)
Unemployment is normal
- Most people change from N into UE, before finally changing into E due to search and matching friction
- N = unemployed and not searching
- Subsidies can encourage more people to enter (N —> L) into the labour market L, and most also falls into the UE group due to frictions
- People can move from active participation to inactive (L —> N)
Our Task
- Our previous analysis of economic fluctuations helps us to understand the fluctuations of unemployment around the natural rate (the cyclical component of the rate of unemployment)
- But what determines the natural rate of unemployment?
Labour Markets
- Separations:
Dismissals, redundancies, firm closures, quits, etc. - Search:
Of workers for firms, of firms for workers (vacancies)
Matches
The search and matching process takes time and effort
A basic model of the natural rate
L = No. of workers in labour force (fixed) (exogenous) —> Employed + Unemployed
E = Number of employed workers (endogenous) —> People who are in a paid job
U = Number of unemployed (endogenous) —> people who are unemployed and looking for as job
Unemployment rate: U/L
1) Working population consists of one more group: Out of Labour Force = E + U + N
2) Out of Labour Force (N) are people not unemployed but not actively finding a job
3) Individuals can move from L to N (i.e., go back to school)
Separations and Findings
- S is separation (E —> UE) = rate of job separation
Fraction of employed workers that become separated from their jobs in a given period (e.g. 1% per month) - Includes both quitting and layoff of workers
- f is job finding (UE —> E) = rate of job finding
Fraction of unemployed workers that find jobs in a given period (e.g. 20% per month) - Dependent on the number of vacancies posted by firms
- Household’s needs vacancies to be employed
- Subjected to search and matching friction
The job finding rate is the percentage of people who becomes employed, and people only get employed if there is a vacancy in the market: this is controlled by firms
S is the percentage who become unemployed. The effects of S are ambiguous and we can’t absolutely determine the overall effect of S
Computing the Natural Rate
- During booms, flows out of unemployed exceed flows in f x U > s x E
- During recessions, flows into unemployment exceed flows out f x U < s X E
- At the natural rate, flows in roughly equal flows out f x U = s x E
Solving for the Natural Rate (steady state)
s x E = f x U s x (L - U) = f x U s x L = (s + f) x U U/L = s/(s + f)
Implications
The natural rate of unemployment is larger if:
S is larger
F is smaller
Unemployment and Economic Fluctuations
In a recession by typical decrease in AD, unemployment rate increases because:
1) Job finding rate decreases -> harder to find a job as firm’s close and scale down production meaning lesser vacancies
2) Separation rate decreases -> some people leave their jobs due to contractions of labour market and/or lower wages, but a lot of people would rather stay in their job
Labour Market Policies and Insitutions
- Some separations and delays in job finding are inevitable, and so is some unemployment
- But policies and institutions can improve the effectiveness of job search, the incentives to both separations and searching, and the willingness of firms to open vacancies
“Active” Labour Market Policies
Government programs to help workers search (increase f):
- Government employs agencies
Disseminate info about job openings to better match workers & jobs
- Conditional unemployment benefits
Incentivise worker search by making UI depended on job search efforts
- Public job training programs
Help workers displaced from declining industries get skills needed for jobs in growing industries
Unemployment Insurance (UI)
Pays part of a worker’s former wages for limited time after the worker loses his/her job
1) Reduces the hardship of unemployment
2) By allowing workers more time to search, UI may lead to better matches between jobs and workers, and thus greater productivity and high incomes
3) May support AD in recession by preserving spending power of the unemployed
The Dark Side of UI
- UI increases search unemployment, because it reduces the opportunity cost of being unemployed (reduces f)
- Studies: The longer a worker is eligible for UI, the longer the average spell of unemployment
- Government problem: choosing the level and duration of UI so as to find the right balance between costs and benefits
Employment Protection Legislation (EPL)
- US model: “fire at will”
- Many other countries: set of policies that make firing workers more costly (highly mandatory severance pay, spelling out conditions for severance)
- Protects workers from excessive insecurity and arbitrary decisions
EPL and unemployment
In principle ambiguous: Lower s (less fixed) Lower f (more tied in/wages/contracts)
- Casual observation
Countries with high EPL tend to have higher unemployment
Politics of EPL
- Conflict between insiders and outsiders
- Insider more politically powerful
The wage setting process
- Many wages no set on the spot
- National Sectoral contracts -> higher wage, fewer workers hired
- Conflict -> insiders want large wage increase (union support)
- > outsiders want lower wage increases
- Disproportionate weight on interests of insiders
- May result in wages that are too high to encourage job creation (f low)
Centralise wage setting under high EPL
- High EPL exacerbates insiders focus on wage increases to the detriment of outsiders
- The higher the EPL, the greater the impact of centralised wage setting (more laws = more gov setting = private firms not as flexible)
Dual Labour Markets
- Temporary jobs without EPL
After a few months must hire permanently or fire - Pros and cons
Unemployed get some work some of the time
No firm incentives to invest in workers, no workers incentive to invest in firm - Result
Middle aged workers secure in permanent jobs
Young workers in unemployment punctuated by brief spells in temporary jobs which don;t build their skills - Recent reforms (Spain, Italy)
“Unified” contact with gradually increasing EP
Payroll taxes
- An important source of government revenue in many countries
- But increases the cost of labour
- Fewer fancies created, hence potentially lower f
- Easy tac to administer -> can’t evade it
Minimum wage
Suppose minimum wage is higher than equilibrium
For separation rate:
Household -> They are happy so won’t suit
Firms -> Since they are already employed, it means that firms are willing to pay them. Won’t randomly lay off workers because minimum wage is higher
For finding rate: Affects only by firm’s vacancies
Firms -> Wage rate is high: leads to decline in demand for labour -> lesser vacancies
Firms -> They could be paying too much to some people who are not that productive -> will not hire those less production: less incentive to employ and post lesser vacancies
Is low wage necessarily bad
- Not necessarily worse off
- Everyone has a reservation value that they are willing to work for
- This value does not compromise of only monastery gains and can include other work-related benefits that are very valuable and may make them better off (location, transport, schools etc..)
