High unemployment rates are mainly caused by cyclical unemployment. This is caused by a decline in the cycle of business. This is part of the normal rise and fall in economic growth over time. The duration of cyclical unemployment depends on how long the recession has caused economic contractions. A typical recession usually lasts 18 months. Unemployed people are rehired when the business cycle enters the expansionary phase.
Causes
A drop in consumer demand leads to a decrease in production. Layoffs are caused by this reduction in the demand for workers. The consumers then have less money to spend which further reduces revenue. This causes the companies to layoff more workers to maintain their profits.
By the time cyclical employment begins, most economies are already in recession. Businesses wait to lay off workers until they are sure that the recession is severe enough.
Stock market crashes can cause cyclical unemployment. Examples include The crash of 1929, the Tech Crash of 2000 and the Financial Crash of 2008. The crash of 1929, the tech crash of 2000, and the financial crash of 2008 are all examples.
Note:
Investors usually begin to sell as soon as prices start to drop. Buyers and consumers reduce their spending to wait and see how much prices fall.
Businesses suffer from a net worth loss when stock prices plunge. The market plunges and so do opportunities to raise money for expansion or growth. Investors begin to lose faith in financial markets. They begin selling their stocks to reduce losses and the stock price begins to drop. Then, consumers tend to wait to make purchases until investor confidence returns, or prices continue to fall.
This is the contractionary phase of the business cycle. Investor confidence will return, and economic growth will resume – the expansionary phase – and cyclical unemployment can be avoided. If investor confidence continues to decline, lower demand forces businesses continue to lay off workers.
Effects of Cyclical unemployment
Unemployment can spiral downward if it is cyclical. As a result, the newly unemployed will have fewer disposable earnings. This will lower demand and business revenues, leading to more layoffs.
This spiral will continue if nothing is done until the supply falls to match the reduced demand. This may not occur until unemployment reaches 25 percent. The Great Depression lasted for a decade and reached this level of unemployment. Although monetary policies had been implemented, they were not sufficient. The demand for military supplies and equipment as the United States entered World War II is widely accepted to be what ended the Depression.
Unemployment Examples
The 2008 financial crisis was a good example of cyclical job loss. Home builders stopped building new homes as the housing crisis developed. Two million construction workers have lost their jobs. 2
A structural unemployment occurs when a workforce lacks the skills and knowledge required. This could be the case in a city that has a tire factory with a large number of employees. They may be highly skilled at the activities and processes of the tire plant but unable to find work as they do not meet the needs of their current employers.
A person can be cyclically unemployed and then become structurally unemployed. During the Great Recession many factories began using sophisticated computer equipment for machinery. Employers laid off employees and realized that they needed fewer people. Workers who had not updated their skills and knowledge became structurally jobless. They no longer had the skills to meet local employer’s needs. 3
For workers to remain relevant, they needed to update their computer and technical skills to be able to manage robots that operate the machinery they used to run.
Note:
- Structural Unemployment is due to a lower-qualified workforce.
- Frictional Unemployment occurs when a person is looking for another job.
- Seasonal unemployment is the absence of seasonal workers. Classical unemployment occurs when wages are high and employers cannot pay their workers.
Find the cyclical unemployment rate
The cyclical rate of unemployment is the difference between the natural rate of unemployment, (unemployment caused by workers moving or looking for work), and the current rate. The data makes it difficult to determine the reasons why each individual is unemployed. Three methods have been developed by economists to determine how much of the measured unemployed is cyclical.
First and most commonly used method is the business cycle. Find the unemployment rate during the peak of the cycle to use this method. Then, calculate the unemployment rate in the trough. Subtract the two, and you’ll get the cyclical rate of unemployment.
Unemployment rate at peak – Unemployment rate at trough = Cyclical unemployment Rate
The cyclical rate is obtained by subtracting the seasonal, structural and frictional unemployment rates from aggregate unemployment.
Comparing the rate of unemployment for recent graduates to the overall rate is the third method. If the rate for recent graduates is the same as the rate overall, then the majority of unemployment in the country is cyclical. The reasoning behind this is that new college graduates are equipped with new skills and they can go wherever jobs are. There is a small chance that they will experience structural unemployment. Researchers found that the majority of unemployment was cyclical in 2011. 4
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In order to prevent cyclical unemployment from spiraling out of control, it is usually the responsibility of the federal government to intervene. First and foremost, a monetary expansion is the easiest way to respond. Federal Reserve (the Fed), can lower interest rates and use other innovative methods in order to influence the economy.
Lowering interest rates encourages consumers to spend more and boosts market confidence. The Fed’s actions may boost confidence and increase aggregate demand. 5
If this is not enough, the government will need to use an expansionary fiscal strategy. The expansionary policy takes longer to implement because Congress has to approve additional federal spending. This spending increases the budget deficit, and ignites the bipartisan debate about whether tax cuts or federal spending is more effective in creating jobs. 6
Note:
Expansionary fiscal policy is a government action that involves increasing or decreasing taxes and spending.
A third option would be for the government to extend unemployment benefits. Selon certains studies, tax reductions are not as effective at creating the demand necessary to end cyclical unemployment.
FAQs (Frequently Asked Questions)
When does cyclical joblessness occur?
During the contraction phase, unemployment is cyclical. These contractions are usually accompanied by a recession and slow down economic growth in the entire economy. Employment rates also fall.
What happens when the cyclical unemployment rate reaches 0%
When the economy is operating at full capacity, cyclical unemployment will reach 0%. It doesn’t mean that there would be no unemployment. A combination of frictional and structural economic forces will create a natural rate of unemployment. According to the Congressional Budget Office, natural unemployment in the United States is estimated at 4.4%.
