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Macro theory of
unemployment
IS-MP
Y
u
Potential
output =
AF(K,L)
Ypot
Three key macro laws for the labor market
Okun’s Law: unemployment moves inversely with Y (earlier
in course)
Beveridge Curve: Unemployment moves inversely with
vacancy rate (today)
Phillips Curve: Inflation moves inversely with
unemployment (Wednesday)
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Some labor market facts
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Unemployment rate
?
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Employment-population ratio
6
Eurozone unemployment rates
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Duration of unemployment
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Why is there unemployment?
•
•
•
•
•
•
•
•
•
•
•
People don’t have the skills for today’s jobs.
All the jobs have gone to China and India.
Supply and demand intersect at zero employment.
Too many people chasing too few jobs.
Unemployment insurance pays too much.
Unions drive up the wages too high.
Capitalism is deeply flawed because of inequality.
People are overqualified.
All the jobs have been outsourced.
Too much money supply.
People have bad attitudes.
P.S. I found each of these on the web.
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Question for you to answer
1. What is the economic definition of unemployment (of
people)?
2. Why is there unemployment (of people) in a market
economy?
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The Current Population Survey (CPS)
• Source of data for monthly unemployment, employment, labor force
data.
• Overview of the survey
• 60,000 households surveyed monthly
• “scientifically selected to represent the civilian non-institutional
population”
• provides estimates of employment, unemployment, earnings, hours of
work, and other indicators
• Definitions:
• Employed = worked for pay or absent from job for cause
• Unemployed = not working plus actively looking for work
• Labor force = E + U
For further information, see
http://www.bls.census.gov/cps/cpsbasic.htm
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Alternative Measures of Unemployment
As % of labor force of labor force+
Sep-06
Sep-13
U-1 Persons unemployed 15 weeks
or longer
1.5
3.8
U-2 Job losers and persons who
completed temporary job
2.1
3.8
4.6
7.2
U-4 Total unemployed plus
discouraged workers
4.8
7.7
U-5 Total unemployed, plus all
persons marginally attached to the
labor force
5.4
8.6
U-6 Total unemployed, plus all
persons marginally attached to the
labor force, plus total employed
part time for economic reasons
8.0
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U-3 Total unemployed
2013
Unemployment by Age
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Economic theory of unemployment
Market-clearing (auction-Walrasian-classical)
Wages move to clear supply and demand
• Workers are on supply curves
• Unemployment is “voluntary”
Non-market-clearing (non-Walrasian): Wages are
determined in a decentralized manner:
• In modern search theories, workers search and “matching” with
firms, but can have unemployment and vacancies when
matching is not perfect.
• Sticky wages and prices. Firms have wage structure (say union
bargain). Firms determine employment (are on their demand
schedules), and workers may be off curves and jobs rationed.
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• Why are so many people unemployed at the same time that there
are a large number of job openings? How can economic policy affect
unemployment? …
• On many markets, buyers and sellers do not always make contact
with one another immediately. This concerns, for example,
employers who are looking for employees and workers who are
trying to find jobs. Since the search process requires time and
resources, it creates frictions in the market. On such search markets,
the demands of some buyers will not be met, while some sellers
cannot sell as much as they would wish. Simultaneously, there are
both job vacancies and unemployment on the labor market.
[From Nobel citation.]
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Search Models of the Labor Market
• Search models: Unemployment arises from “search” and “labor
market frictions” (Mortensen-Pissarides model is standard)
• Heterogeneous firms and workers are like molecules, bouncing
around looking for jobs or workers.
• When they meet, and if there is surplus*, they match and bargain
for a wage.
• Have job creation and destruction by economic forces
• This leads to equilibrium “frictional” unemployment and
vacancies depending on various parameters.
• This generates a “Beveridge curve” over the cycle.
• A change in the structure may shift the Beveridge curve out or in.
• But search models have not yet been successful in
predicting the cyclical pattern of wages and employment
changes.
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Vacancy =
Unemployment =
Match =
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Basics of search models of labor market
[Will put reading on list.]
Labor force, L
Unemployment = uL
Vacancies = vL
φ = exogenous rate of job destruction
Labor market “tightness” = θ = v/u = slope of Beveridge curve
Unemployed workers find jobs at rate of α = α(θ), α'(θ) > 0
Firms fill vacancies at rate q = q(θ), q' (θ) < 0 [doesn’t enter in (1)]
In steady state, job creation (αuL) equals job destruction (φ(1-u)L).
Steady state unemployment when flows are in equilibrium:
(1)
u* 



   ( )    ( v * /u*)
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Derivation of Beveridge curve
(1)


u* 

   ( )    ( v * /u*)
which yields a negative relationship between u and v.
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Search model continued
Steady state unemployment when flows are in equilibrium:
(1) u* 



   ( )    ( v * /u*)
Notes:
• Eq (1) shows the (u,v) pairs that are consistent with the search
equilibrium and is the Beveridge curve.
• We need another equation to close the system. The other equation
might be aggregate demand or productivity.
• Changes in φ or α will shift the Beveridge curve.
• Note that if the matching function deteriorates, then the Beveridge
curve shifts out.
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Note the shift from
1960s to 1980s.
Probably due to
increase in structural
change.
Source: FRBSF Economic
Letter, 2006-08; April 21,
2006, Job Matching: Evidence
from the Beveridge Curve
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What happens in recessions and booms?
In recessions, the rate of job destruction increases.
This leads to high u, lower v, and a movement along the Beveridge
curve.
recession
boom
So far, the models have not matched the dynamics quite right, probably
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because the wage determination is misspecified.
U.S. Beveridge curve
Has the Beveridge
curve shifted out in
Great Recession?
Very worrisome for
the level of full
employment
(NAIRU/natural rate).
Is it temporary or
permanent?
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Bureau of Labor Statistics
How much are the unemployed searching
Alan B. Krueger and Andreas Mueller, “The Lot of the Unemployed: A Time Use Perspective”.
“Min” are minutes per day.
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The market failure approach
Need to understand how labor markets function.
Alternative mechanisms for balancing supply and demand:
- Auctions (financial markets, stock markets, …)
- Firms post prices or wages (union contracts, Yale tuition, …)
- Buyers and sellers bargain (houses, baseball players,…)
Major point about labor markets is that wages are sticky
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2012-09-01
2010-07-01
2008-05-01
2006-03-01
2004-01-01
2001-11-01
1999-09-01
1997-07-01
1995-05-01
1993-03-01
7%
1991-01-01
8%
1988-11-01
9%
1986-09-01
1984-07-01
1982-05-01
1980-03-01
1978-01-01
1975-11-01
1973-09-01
1971-07-01
1969-05-01
1967-03-01
1965-01-01
How do wages respond to a glut of workers?
Rate of nominal wage inflation
10%
Wages tend to display “nominal
stickiness” and “downward
rigidity.”
6%
5%
4%
3%
2%
1%
0%
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Flexible oil prices v. sticky wages
6.0
4.0
Hourly earnings
Oil prices
2.0
1.6
1.2
0.8
0.6
0.4
0.2
1980
1985
1990
1995
2000
2005
2010
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The Issue of Wage-Price Flexibility
The single most important issue in labor and inflation theory
revolves around the question of the flexibility of wages and
prices.
This in turn mainly concerns the flexibility of wages
Major historical developments:
1. Nominal wage change became much less volatile.
2. Nominal wages became downwardly rigid.
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Wage declines in American History
.00
-.05
1933 - 2013:
no declines in
nominal wages
-.10
-.15
-.20
-.25
-.30
1850
1875
1900
1925
1950
1975
2000
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Distribution of wage increases
(nominal, percent year over year)
Distribution
-10 to -5%
-5 to 0%
0 to 5%
5 to 10%
10%+
Total
1866-1928
1946-2013
13%
24%
48%
6%
8%
0%
0%
68%
30%
2%
100%
100%
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Why are wages rigid?*
1. Rise of unionization and worker representation
2. Rise of multi-year nominal contracts
3. Social norms against nominal wage reductions
4. Money illusion on nominal wage reductions
From an microeconomic point of view, wages are sticky because
it is costly for employers to adjust them rapidly (“menu
costs” in “New Keynesian macroeconomics”)
This poses deep problems for countries that need to “deflate”
their costs: e.g., all of southern Europe!
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Final Thoughts on Unemployment
Unemployment exists because of frictions in labor markets
as people and firms try to find good matches.
Unemployment rises in recessions as jobs are destroyed
because output rises less rapidly than potential output
(for Keynesian reasons)
Equilibrium (full employment) unemployment can be
affected by labor-market policies that improve matching,
searching, skills, and the like
… but these will not help in deep recessions where the
constraint is inadequate aggregate demand.
People are worried today about the impact of the long
recession on the level of mismatch.
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