UNEMPLOYMENT &

INFLATION

Barbra Gwokyalya
Business Cycle

 Business Fluctuations
 The ups and downs in business activity
throughout the economy
 Expansion
 A business fluctuation in which the pace of
national economic activity is speeding up
 Contraction
 A business fluctuation during which the
pace of national economic activity is
slowing down
Business fluctuations
Recession
A period of time during which the rate of growth of
business activity is consistently less than its long-term
trend or is negative

Depression
An extremely severe recession
Two major economic problems resulting
fromUUUUUUU Business cycles
1. Unemployment
The Costs of Unemployment are
 The loss of output for the Economy and loss of income for the
individual.
 Okun's law: For every 1% increase in the unemployment rate,
Real GDP declines by 2%
 Leads to increases in Poverty
 Loss of Human Capital
 Human capital is the skills & knowledge of workers
 Social and Political problems
2. Inflation: An increase in the overall Price level as measured by a
price index.
Sometimes referred to as an increase in the cost of living.
Defining Unemployment

 Employment is the number of people

currently employed in the economy, either full time
or part time.
 Unemployment is the number of people who are
actively looking for work but aren’t currently employed.
 The labor force is equal to the sum of employment
and unemployment.
 Official unemployment statistics are done by
 Uganda National Bureau of Statistics (UBOS)
Unemployment Rate

 Workers can become unemployed for a variety

of reasons and some are unemployed for short
or long periods of time.
Two basic reasons for why workers become
unemployed:
1. Job Losers: Workers who lost their last job
involuntarily usually because their last job was
eliminated.
2. Job Leavers: Workers who quit their last job.
A small part of the unemployment rate is from
job levers, and it stays constant over the
business cycle.
The Nature of unemploymen
 FRICTIONAL Unemployment is unemployment due
 People are either voluntarily changing jobs, or
Re entering the workforce.

unemployment does not last a long time.
 The reason they are unemployed is that they
employers because of a lack of information about the
available job openings.
 Why? Information is costly.

 Structural unemployment is unemployment that results when there

are more people seeking jobs in a labor market than there are jobs
available at the current wage.
The Nature of

 Minimum wages - a government-mandated floor on the price

of labor.
 Unions - by bargaining for all a firm’s workers collectively
(collective bargaining), unions can often win higher wages
from employers than the market would have otherwise
provided when workers bargained individually.
 Efficiency wages - wages that employers set above the
equilibrium wage rate as an incentive for better
performance.
 Side effects of government policies - public policies
designed to help workers who lose their jobs;
 these policies can lead to structural unemployment as an
unintended side effect by lowering the cost of being
unemployed.
Structural Unemployment

 Those who are most likely not to be able to find the scarce jobs are those
with a lack of marketable skills from changes in the Economy.
 Changes in the economy can come from:
Technological change
Consumer demand changes
International competition
 The workers who have lost jobs find their skills are not in demand and
tend to be unemployed for long periods of time, six months or more.
 These workers need retraining, additional education, or a new
geographic location. It is a long term problem.
The Natural Rate of Unemployment

 The natural rate of unemployment is the normal unemployment rate

around which the actual unemployment rate fluctuates.
 It is the unemployment rate that arises from the effects of frictional
plus structural unemployment.
 It is considered to be the unemployment rate that exists when the
economy is at Full Employment
 Cyclical unemployment is a deviation in the actual rate of
unemployment from the natural rate.
 It can be positive or negative
 When it is positive the actual unemployment rate is greater than
the natural rate of unemployment. Usually cause by a recession.
 Since recessions are temporary, cyclical unemployment will not
always exist in the economy.
The Natural Rate of Unemployment

Natural unemployment = Frictional unemployment + Structural unemployment

Cyclical unemployment = Actual unemployment - Natural unemployment
The natural unemployment rate does change over time,
but actual unemployment does so gradually. It depends on:
1. Demographics of the Labor Force
Amount of younger vs. older workers
2. Institutional changes
Amount of Labor Unionization
Technological changes in labor market: i.e. internet searching
3. Government Policies
Unemployment compensation
Job Training & employment subsidies
Causes of Unemployment
1. Rapid population growth
2. Industrialisation focusing on capital

intensive technology
3. Over dependence on a few export costs
4. Political instability
5. Lack of proper manpower planning
6. The wage gap between the rural and
urban wage
7. Education system; trained to be job
seekers and not job creators.
Measures to control
Unemployment
 To control population growth
 Changing education system by training job
 Industrialization focusing on labour intensive
technology
 Improving manpower planning
 Improving the rural wage
 Improvement in the social services
 Improvement in the infrastructure
 Rural development – setting up industries in rural areas.
 Increase in government expenditure (provision of loans)
Measures to control
Unemployment
 Decrease in taxes (i.e.
Expansionary fiscal policy)
 Increase in money supply
 by reducing interest rates,
providing financial support.
 Improvement in information
 Political stability
 Improvement in the marketing of agricultural products.

 Carrying out land reforms

 Creating vocational and counselling centers.
 WIINFLATOIat is Inflation?
 Inflation can be defined as an increase in the price level measured by
consumer price index or a decline in the value of a unit of money.

• It is the rate of change that is important, not the actual

price level.
• An economy can function at any price level, but it is
difficult for to function well if average prices are rising
or falling rapidly.
• Calculating real values is important
Real ValCosts of inflation
Long-term contracts are generally written in dollar
terms. That is, loans and bonds are paid off
years into the future.
Loans and bonds are quoted with nominal interest
rates – you pay back in dollars and are paid back in
dollars
Question: How much are those dollars worth in the
future?
It depends on the expected inflation rate.
Need a real value: real interest rate which is the
amount earned or paid after adjusted for inflation.
Costs of inflation - Continued

Since it is very difficult to accurately forecast the

expected inflation rate winners & losers are created
with unexpected inflation.
If inflation is greater than expected the debtors win and
creditors lose (pay back loans with less valuable money)
Costs of inflation - Continued
Costs of Inflat
If creditors could accurately forecast inflation in the future
debtors couldn’t benefit since creditors would demand
higher nominal interest rates to compensate them for the
loss in the value of money.
That is nominal interest rates have to include an inflation
premium to compensate creditors for the risk they take if
inflation is higher than expected.
It must be at least the expected inflation rate.
Examples:
1. Adjustable interest rates on loans allows creditors to
change the interest rate periodically.
2. Governments issue inflation indexed bonds where the
principal is adjusted based on changes in the CPI so
your purchasing power is guaranteed.
Co
 Shoe-leather costs are the increased costs of more
frequently going to the bank to get money since you
will want to hold onto less of it on a daily basis.
 Menu cost is the real cost of changing a listed price.
cost of printing new menus
cost of printing & mailing new
catalogs
cost of changing tags on items
in a store

The higher is inflation, the more frequently firms must change their prices and
incur these costs.
Costs of inflation

 Unit-of-account costs arise from the way

inflation makes money a less reliable unit of
measurement.
 Distorts the allocation of goods and
resources which reduce the efficiency of the
economy.

 Hard to do long term financial planning

 Unfair tax treatment: pay taxes on
nominal gains, not real gains.
Economics in Action
 In the mid-1980s, Israel experienced a “clean” inflation: there was no war,
the government was stable, and there was order in the streets.
 But policy errors led to very high inflation.
 The shoe-leather costs of inflation were substantial. Israelis spent a lot of
time moving money in and out of bank accounts that provided high enough
interest rates to offset inflation.
 Businesses made efforts to minimize menu costs.  For
example, restaurant menus often didn’t list prices.
 It was hard for Israelis to make decisions because prices changed
so much and so often.
Another way to estimate how bad inflation is to
use the Rule of

Rule of 70:

70 / Annual inflation rate =

Approximate # of years for the price
level to double.
Example: If the inflation rate is 2% per
year then it would take 70/2 = 35 years
for the price level to double
Types of inflation

 Creeping inflation
The rate of inflation doesn’t exceed the
rate of production growth; Creeping
inflation is < 10%
Galloping inflation
 the rate of inflation exceeds the rate of
production growth; Galloping inflation is
from 10% to 100%. Money loose purchase
power, people hold as little money as
possible.
Types of inflation - continued

 Hyperinflation
 is inflation that is "out of control", a
condition in which prices increase rapidly
as a currency loses its value.
Hyperinflation is over 100% per year.
Prices as well as wages are extremely
erratic. Money has no value and barter
trade emerges (barter means the
exchange of goods for goods and services).
Example: Germany after WW1(World War
I), Hungary after II.WW (World War II).
Types of inflation - continued

 Open inflation
If economic imbalance is accompanied with
rising price level.
 Suppressed inflation
If state authorities damp or even stop the rise
of price level by administrative means. Such
situation is followed by existence of scarce
commodities, shadow economy etc.
In such cases the provision of basic necessities
such as agricultural products is set by the
government by introducing price controls on
commodities
Causes of Inflation
How Inflation is initiated
1. Demand Pull inflation
Desired Spending is greater than ability of the
economy to produce the necessary of goods and
services (demand pull).
"Too much money chasing too few goods”
Possible causes of demand-pull inflation:
Excessive investment expenditures
Excessive growth of consumption expenditures
Low - cost loans
Tax cutting
Augmentation of government expenditures
2. Cost Push inflation
A rise in per unit production costs
which causes firms to raise prices
(cost push).
Possible causes of cost push
inflation;
a. Wage increases without productivity increases
b. Supply shock: decline in the supply of
an important input such as oil or food.
Causes of cost push inflation

c. Imperfect competition (Monopoly)

d. Increased taxes
3. Built-in inflation
(or anticipated inflation)

induced by adaptive expectations, often linked to the

“price/wage spiral”
Built-ininflation reflects events in the past, and so
might be seen as hangover inflation.
4. Structural / Bottleneck
Inflation
Demand pull and cost push inflation
theories cannot fully explain the
inflation tendency, need is required to
look into the problems of the economy.
It is due to the structural problems
which keep the level of output low and
prices high.
Causes of structural/Bottleneck inflation

 Structuralbreak down: this will cause a shortage of machines

depreciate and there is inadequate capital economy and this may be
due to the uncontrollable invasion, pests and diseases, e.t.c.

reduces the level of output leading to high
prices.
Foreign exchange bottlenecks and this may be
due to poor export performance.
If the export sector performs below capacity, less
forex is obtained to buy capital equipments which
can be used to set up industries to increase the
productive capacity of the economy.
 Causes of
structural/Bottleneck
inflation
 It can also be due to lack of expertise or skills which
result into a decline in supply of commodities leading
to a sharp increase in prices
 Political instability. This will scare away both the
local and foreign investors, output reduces while
prices increase
Policy measures to curb
structural inflation
A
gricultural and industrial products are exported
of exports should also be improved.
The agricultural sector should be improved in transport facilities,
encouraging transport reforms. Also to increase agricultural
commodity facilities to farmers (incentives).
Effects of Inflation
1. Redistribution effect of inflation
 Inflation affects recipients of fixed
income firstly (nominal
 incomes remain same but the real value
of income drop)
 Inflation affects the purchasing power
of wages that don’t follow the rise of
prices
 Inflation causes diminishing value of
loans and savings
Effects of inflation

2. Social impact of inflation

Socially poor persons suffer from
inflation more than the rich.
3. Impact on economy balance
 Fall of real product below potential
product.
Changes in the structure of consumption
(consumers are buying cheaper goods)
 In case of fixed currency exchange
rate higher exports are incited.
Curbing Inflation
1. Managing the wages and prices–determined by state
income policy (authority can set wages ceiling)
2. Stimulating market competition – e.g. antimonopoly
regulations
3. Fiscal and monetary policy – e.g. central banks can
affect inflation to a significant extent through setting
interest rates
The Phillip’s Curve
The Phillip’s Curve
 Suggests an inverse relationship (or a trade-off) between inflation
and the unemployment rate( When Inflation increases,U/E reduces)
 Named after Alban William Phillips, a British economist who
originally discovered the relationship between unemployment and
nominal wages, using British data in 1950s.
The Phillip’s Curve

In general, inflation is associated with economic

expansion, and unemployment with economic recession.
During expansion: the greater the rate of growth of
Aggregate Demand - inflation is high, and
unemployment is low.
During recession: the slower the rate of growth of
Aggregate Demand -inflation is low, and unemployment
is high.
 Summary
1. Inflation and unemployment are the main concerns
of macroeconomic policy.
2. Employment is the number of people employed;
unemployment is the number of people unemployed
and actively looking for work. Their sum is equal to
the labor force, and the labor force participation
rate is the percentage of the population age 16 or
older that is in the labor force.
3. The unemployment rate can overstate because it counts as
unemployed those who are continuing to search for a job
despite having been offered one (that is, workers who are
frictionally unemployed). It can understate because it ignores
frustrated workers, such as discouraged workers,
marginally attached workers, and the
underemployed.
 Summary
4. The unemployment rate is affected by the business cycle. The unemployment
rate generally falls when the growth rate
5. of real GDP is above average and generally increases when the growth rate of
real GDP is below average.
6. Job creation and destruction, as well as voluntary job separations, lead to job
search and frictional unemployment. In addition, a variety of factors such as
minimum wages, unions, efficiency wages, and
government policies designed to help laid-off workers result
in a situation in which there is a surplus of labor at the market wage rate, creating
structural unemployment.
As a result, the natural rate of unemployment, the sum of frictional and structural
employment, is well above zero, even when jobs are plentiful.
 Summary
6. The actual unemployment rate is equal to the natural rate
of unemployment plus cyclical unemployment.
7. The natural rate of unemployment changes over time.
8. Policy makers worry about inflation as well as
unemployment.
9. Inflation does not, as many assume, make everyone poorer
by raising the level of prices. That's because wages and
incomes are adjusted to take into account a rising price
level, leaving real wages and real income unaffected.
However, a high inflation rate imposes overall costs on the
economy: shoe-leather costs, menu costs, and unit-of-
account costs.
 Summary

10. Inflation can produce winners and losers within the

economy, because long-term contracts are generally
written in dollar terms. Loans typically specify a
nominal interest rate, which differs from the real
interest rate due to inflation. A higher-than-expected
inflation rate is good for borrowers and bad for
lenders. A lower-than expected inflation rate is good
for lenders and bad for borrowers.
11. Disinflation is very costly, so policy makers try to
prevent inflation from becoming excessive in the first
place.