8.4 SUMMARY

1. Inflation and unemployment are the twin evils of macroeconomics and 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 labour force, and the labour force participation rate is the percentage of the population age 15 or older that is in the labour force.

3. The unemployment rate, the percentage of the labour force that is unemployed and actively looking for work, can both overstate and understate the true level of unemployment. It can overstate because it counts as unemployed those who are continuing to search for a job despite having been offered one. It can understate because it ignores frustrated workers, such as discouraged workers, marginally attached workers, and the underemployed, including those who are visibly and invisibly underemployed. In addition, the unemployment rate varies greatly among different groups in the population; it is typically higher for younger workers and for workers near retirement age than for workers in their prime working years.

4. The unemployment rate is affected by the business cycle. The unemployment rate generally falls when the growth rate of real GDP is above average and generally increases when the growth rate of real GDP is below average. A jobless recovery, a period in which real GDP is growing but unemployment rises, often follows recessions.

5. 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, government policies designed to help laid-off workers, and mismatch between employees and employers, results in a situation in which there is a surplus of labour 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.

6. The actual unemployment rate is equal to the natural rate of unemployment, the share of unemployment that is independent of the business cycle, plus cyclical unemployment, the share of unemployment that depends on fluctuations in the business cycle.

7. The natural rate of unemployment changes over time, largely in response to changes in labour force characteristics, labour market institutions, and government policies.

8. 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.

9. Inflation can produce winners and losers within the economy, because long-term contracts are generally written in dollar terms. The interest rate specified in a loan is typically 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. Unexpected inflation is the difference between the expected rate of inflation and the actual rate. Some pensions are subject to indexing, so a retired person’s income keeps pace with inflation.

10. Many believe policies that depress the economy and produce high unemployment are necessary to reduce embedded inflation. Because disinflation is very costly, policy-makers try to prevent inflation from becoming excessive in the first place.