Employment and Unemployment

A major macroeconomic indicator is the unemployment rate. In the United States, the Bureau of Labor Statistics (BLS) conducts a monthly survey of a sample of households in which it asks whether individuals in the household are employed or have searched for work recently. Those who have done neither are deemed to be out of the labor force. Of those in the labor force, the percent that is not working is the unemployment rate.

Another employment survey is called the payroll survey. The BLS asks all large employers and a sample of small employers to report the number of employees on their payrolls. This gives an alternative measure of total employment, one that is considered to be a bit more reliable than the household survey.

When aggregate demand (what we have been calling Y in our equations) goes up in the economy, employment goes up and unemployment goes down. This makes sense, because as firms must meet the need for more output, they have to hire more workers.

A typical unemployment rate for the U.S. economy might be 6 percent. However, it is important to realize that many more than 6 percent of workers experience spells of unemployment over the course of a year. Each month a large percentage of the labor force engages in transitions. Many people leave their old jobs. Some start new jobs right away, and others remain unemployed for a few months.

Economists Bruce C. Fallick and Charles A. Fleischman estimated that about nine million employment relationships end each month, due either to quits by workers or lay-offs by firms. Also, about nine million new employment relationships start each month. The change in the unemployment rate represents the difference between relationships newly broken and relationships newly started. A change in the number of unemployed of 250,000 will move the unemployment rate by 0.2 percentage points (from, say 6.0 percent to 6.2 percent), which is enough to be remarked on in the news media. In other words, in a month where 9 million jobs are terminated and only 8.75 million jobs are created, the unemployment rate will rise noticeably.

Another way of looking at the delicacy of the unemployment rate is to think of it in terms of the average spell for those who are unemployed. Suppose that 24 percent of the labor force experiences a spell of unemployment over the course of a year, and that the average spell is three months, or 1/4 of the year. Then the average unemployment rate is 24/4 = 6 percent. If the average unemployment spell were to lengthen to four months (1/3 of the year), then the unemployment rate would rise to 24/3 = 8 percent.

From the foregoing, it should be evident that the key to maintaining full employment is job creation. As long as new jobs are being created at a sufficient rate to absorb people leaving old jobs as well as new entrants to the labor force, the economy can experience a large number of layoffs and yet not have an unusually high unemployment rate. The media was reporting massive layoffs at major corporations throughout the 1990's, as the unemployment rate persistently declined. For most of the 1990's new job creation was strong, so that average unemployment spells shortened, reducing the overall unemployment rate.

High Unemployment

If hyper-inflation is a particularly frustrating form of inflation, then its counterpart in unemployment is a severe recession or depression, in which the unemployment rate reaches double-digit levels and stays there. For example, in the Great Depression in the 1930's in the United States, the unemployment rate reached as high as 33 percent, and it was over 20 percent for nearly a decade.

It was the experience of the Great Depression, which was experienced by most economies of the developed world, that stimulated the development of macroeconomics, primarily the work of English economist John Maynard Keynes. Keynes focused on the link between aggregate demand and unemployment, and he provided the theory of the multiplier, which suggested that the government could alleviate high unemployment with stimulative fiscal and monetary policy.

Since World War II, the United States has not suffered anything close the the Great Depression. Although Keynes has gone in and out of favor, for the most part our political leaders accept responsibility for maintaining low unemployment and believe in the use of fiscal and monetary policy for that purpose.

Microeconomic Causes of Unemployment

In addition to macroeconomic factors, there are microeconomic causes of unemployment. Taxes, welfare policies, and regulatory policies can affect the unemployment rate. Here are some examples.

  1. In many European countries, it is illegal for firms above a certain size (say, 20 employees) to lay off an employee without going through an approval process with the government. This makes firms very leery about hiring new workers, because the firm knows that it will be stuck with the worker even if demand falls off or the relationship does not work. Because firms are reluctant to add workers, new jobs are not created as fast as in the United States, and economists believe that the effect of these laws is to increase the unemployment rate in Europe.

  2. During a recession, one policy issue that comes up is extending unemployment benefits to cover a longer period of time. While this often is the right thing to do for other reasons, it does reduce the incentive of unemployed workers to take new jobs, which tends to raise the unemployment rate.

  3. Income and payroll taxes drive a wedge between the value of a worker's time and the income that a worker can receive from paid employment. If I only take home 50 cents of every dollar I earn, then I may choose to putter around the house more and work less. This can show up as an increase in the unemployment rate, as I look for work but get very picky about the jobs that I will accept.