Inflation and Unemployment : Issues & Measurement

Contents

The Sacrifice Ratio The Costs of Unemployment The Costs of Inflation

The Sacrifice Ratio

- the percentage of output lost for each 1 point reduction in the inflation rate

Unemployment

Okuns Law: The Relation Between Unemployment and GDP Growth in US Economy

Labour Force
consists of people who respond that they are unemployed as well as those who are employed An unemployed person is defined as one who is out of work and who -has actively looked for work during the previous 4 weeks or, -is waiting to be recalled to a job after having being laid off

Variation in Unemployment across Groups

The aggregate rate of unemployment conceals wide variations across various groups of population Age Race Gender The overall unemployment rate is a weighted average of the unemployment rates of the groups The overall unemployment rate can change due to Change in the unemployment rate of any group Shifting of weights

Unemployment Rate by Demographic Group in US : 1997

Age White Male White Female Black Male Black Female 16-19 14.3 12.8 36.5 28.7 20 and over 3.6 3.7 8.5 8.8

Cyclical and Frictional Unemployment

Frictional unemployment exists when the economy is at full employment -same as the natural rate of unemployment

Cyclical unemployment is unemployment in excess of frictional unemployment It occurs when output is below its full-employment level

Determinants of the Natural Rate

Organization of the labour market Availability of unemployment benefits Variability of demand for labour across different firms Rate at which new workers enter labour force Extended period of high unemployment (Unemployment hysteresis) The natural rate is the weighted average of the natural rates of unemployment of the subgroups in the labour force

Unemployment Benefits
Unemployment benefits increase the rate of unemployment in two ways : Unemployment benefits allow longer job search The consequences of being out of jobs are less severe

Unemployment benefits raise the measured unemployment through reporting effects

The Natural and Actual Rates of Unemployment, 1948-2002

The Costs of Unemployment

Total output is below its potential level The economy loses about 2% of output for each 1% that the unemployment rate exceeds the natural rate Distributional impact of unemployment Burden of unemployment

The Costs of Inflation

Perfectly anticipated Imperfectly anticipated

Perfectly Anticipated Inflation

All contracts will be based on the expected rate of inflation Long term labour contracts would take into account of the inflation Nominal interest rates would be raised to compensate for the inflation The costs of fully anticipated inflation are small The costs of holding currency will increase with the inflation rate Shoe-leather costs will increase

Imperfectly Anticipated Inflation

The possibility of unanticipated inflation introduces risk Realized real interest rate are lower than nominal interest rates Inflation redistributes wealth between debtors and creditors

Indexation
Inflation and housing Indexed debt Indexation of wages Supply shocks and wage indexation Why not index?

Is a little inflation good for the economy?

Hyperinflation
-exceeds 50% per month which is just over 1% per day Price of daily newspaper in Germany (in marks) Jan.1921 May,1922 Oct.1922 Feb.1923 Sept.1923 Oct.1923 Oct.15,1923 Oct.29,1923 Nov.9,1923 Nov.17,1923 0.30 1 8 100 1000 2000 20000 1 million 15 million 70 million

Unemployment Rate in India (Rural)

30

1993-94 2004
25 24 22 20 20 Per 1000 persons

15

14

10

0 Male Female

Unemployment Rate in India (Urban)

100

1993-94
90

89 83

2004
80 70 Per 1000 persons 60 50 40 30 20 10 0 Male 46

45

Female