Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 15
Unemployment Fluctuations and
the NAIRU
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Chapter Outline/Learning Objectives
Section
Learning Objectives
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After studying this chapter, you will be able to
15.1 Employment and
Unemployment
1. compare employment and unemployment
trends over the short run and long run.
15.2 Unemployment Fluctuations
2. distinguish between market-clearing and nonmarket-clearing theories of the labour market.
15.3 What Determines the
NAIRU?
3. discuss the causes of frictional and structural
unemployment.
4. explain the various forces that cause the
NAIRU to change.
15.4 Reducing Unemployment
5. discuss policies designed to reduce
unemployment.
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15.1 Employment and Unemployment
• In the long run, increases in the labour force are more
or less matched by increases in employment.
• In the short run, the unemployment rate fluctuates
considerably because changes in the labour force are
not exactly matched by change in employment.
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Changes in Employment (1 of 3)
• In 1976, there were approximately 9.7 million
employed Canadians. By January 2020 (just before
the onset of the COVID-19 pandemic), total
employment was 19.2 million.
• The actual amount of employment is determined both
by the demand for labour and by the supply of labour.
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Changes in Employment (2 of 3)
Figure 15-1 Canadian Unemployment Rate, 1976–2021
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Changes in Employment (3 of 3)
• There are three main causes of the increase in
Canada’s labour force:
1. A rising population, which boosts entry into the labour
force of people born 15 to 25 years previously.
2. Increased labour force participation by various
groups, especially women.
3. Net immigration of working-age persons.
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Changes in Unemployment (1 of 2)
• 1980s:
– Worldwide unemployment rose to high levels
– From a high of more than 12 percent in 1983, the
unemployment rate fell to 7.5 percent in 1988
• Early 1990s: recession
– The unemployment rate reached 11.3 percent by 1992
but dropped to 6.8 percent by early 2000 after five
years of steady economic recovery
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Changes in Unemployment (2 of 2)
• Worldwide recession (2008)
– Canadian economy fared much better than others
– Unemployment increased only to 8.7 percent at the
depth of the recession in mid-2009.
• COVID-19 pandemic
– The unemployment rate reached from 5.8 percent just
before the pandemic to 13.7 percent in the pandemic’s
first few months.
– Throughout 2020 and well into 2021, the
unemployment rate declined as several parts of the
economy re-opened.
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Flows in the Labour Market
• 2014‒2016: the Canadian unemployment rate was
roughly constant at 7 percent.
• This does NOT mean that no jobs were created during
the year.
– Workers were finding jobs at a rate of between 500 000
and 600 000 per month.
– At the same time, other workers were leaving jobs or
entering the labour force at roughly the same rate.
• The amount of activity in the labour market is better reflected
by the flows into and out of unemployment than by the
overall unemployment rate.
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Measurement Problems
• The official data understate the full effects of
recessions on unemployment because they do not
include:
– discouraged workers
– underemployed workers
• Consequences of Unemployment
• Two important costs associated with unemployment
are:
– lost output
– personal costs
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15.2 Unemployment Fluctuations
• In “market-clearing” theories, real GDP = Y*.
• The only unemployment is frictional and structural, and
the unemployment rate is always equal to the NAIRU.
• A second set of theories emphasizes the distinction
between the unemployment that exists when real GDP is
equal to Y*, and unemployment that is due to deviations
of real GDP from Y*.
• Cyclical unemployment is unemployment not due to
frictional or structural factors; it is due to deviations of
GDP from Y*.
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Market-Clearing Theories (1 of 3)
• Market-clearing theories explain fluctuations in
employment and real wages as having one of two
causes.
1. Changes in technology that affect the marginal
product of labour will lead to changes in the
demand for labour.
2. Changes in the willingness of individuals to work will
lead to changes in the supply of labour.
• Whatever unemployment exists must be caused by
frictional or structural causes, the two components of the
NAIRU.
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Market-Clearing Theories (2 of 3)
• Market-clearing theories of the labour market assume
that real wages always adjust to clear the labour
market.
• People who are not working are assumed to have
voluntarily withdrawn from the labour market.
• There is no involuntary unemployment.
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Market-Clearing Theories (3 of 3)
Figure 15-2 Employment and Wages When Labour Markets Clear
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Non-Market-Clearing Theories (1 of 2)
• When the wage rate
does not change
enough to equate
quantity demanded with
quantity supplied, there
will be unemployment in
slumps and labour
shortages in booms.
Figure 15-3 Employment and Sticky Wages When Labour
Markets Do Not Clear
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Non-Market-Clearing Theories (2 of 2)
• Why do wages not quickly adjust to eliminate
involuntary unemployment?
1. Long-term employment relationships
2. Menu costs
3. Efficiency wages
4. Union Bargaining
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15.3 What Determines the NAIRU? (1 of 2)
• When real GDP is equal to potential output, the
unemployment rate is equal to the NAIRU, and there is
only frictional and structural unemployment.
• Frictional Unemployment
– The normal turnover of labour causes frictional
unemployment to persist, even if the economy is at
potential output.
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15.3 What Determines the NAIRU? (2 of 2)
• Structural Unemployment
– The pace of economic change
– Policies that inhibit change
– The COVID-19 pandemic of 2020-2021 offers an
example of an increase in structural unemployment.
There was a significant mismatch in skills, experience,
and industry between the unemployed workers from
most impacted by the pandemic and the new job
vacancies in the expanding industries.
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The Frictional-Structural Distinction (1 of 2)
• In a sense, structural unemployment is really longterm frictional unemployment.
• Suppose there was an increase in world demand for
Canadian-made car parts and at the same time a
decline in world demand for Canadian-assembled
cars.
• Labour would move from the car-assembly sector to
the car-parts manufacturing sector.
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The Frictional-Structural Distinction (2 of 2)
• If the reallocation were to occur quickly, we would call
the unemployment frictional; if the reallocation were to
occur slowly, we would call the unemployment
structural.
• In practice, structural and frictional unemployment
cannot be separated.
• But the two of them, taken together, can be separated
from cyclical unemployment.
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Why Does the NAIRU Change? (1 of 2)
• Demographic Shifts
– Greater labour force participation by groups with high
unemployment rates increases the NAIRU.
– The proportion of young workers in the labour force
rose significantly and increased the NAIRU as the
baby-boom generation of the 1950s entered the labour
force in the 1970s and early 1980s.
– NAIRU decreased as the baby-boom generation aged,
and the fraction of young workers in the labour force
declined in the late 1990s and early 2000s.
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Why Does the NAIRU Change? (2 of 2)
• Demographic Shifts (continued)
– In the 1960s and 1970s, women tended to have higher
unemployment rates than men at all points of the
business cycle.
– When female labour-force participation rates increased
in the 1960s and 1970s, the NAIRU increased.
– In recent years, female unemployment rates have
dropped below the rates for men, and so further
increases in female participation will tend to decrease
the NAIRU.
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Figure 15-4 Canadian Unemployment Rates by
Demographic Groups, April 2021
Unemployment is unevenly spread among different groups in the labour force. In April of 2021, when the overall
unemployment rate was 8.1 percent, the unemployment rates for youths (of both sexes) were considerably higher.
(Source: Based on Statistics Canada Table 14-10-0287-01.)
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Hysteresis (1 of 2)
• In some models, the level of the NAIRU can be
influenced by the current state of unemployment.
• These models get their name from the Greek word
hysteresis, meaning “lagged effect.”
• If a recession causes a significant group to encounter
unusual difficulty obtaining their first jobs, they will be
slow to acquire important skills.
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Hysteresis (2 of 2)
• When demand increases again, this group of workers
will take longer to find jobs and the NAIRU will be
higher than it would have been had there been no
recession.
• In a heavily unionized labour force, people who are
currently employed (insiders) may use their bargaining
power to prevent new entrants to the labour force
(outsiders).
• If outsiders are denied access to the labour market,
their unemployment will fail to exert downward
pressure on wages, and the NAIRU will tend to rise.
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Globalization and Structural Change
• Canadian labour markets are increasingly affected by
changes in demand and supply conditions elsewhere
in the world.
• As Canadian labour markets require more frequent
and larger adjustments to economic events occurring
in other parts of the world, the NAIRU will tend to
increase.
• Policy and Labour-Market Flexibility
– Any government policy that reduces labour-market
flexibility is likely to increase the NAIRU.
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15.4 Reducing Unemployment
• Cyclical Unemployment
• There is debate over how much government can and
should do to reduce cyclical unemployment.
– Advocates of stabilization policy call for expansionary
fiscal and monetary policies to reduce persistent
recessionary gaps.
– Advocates of the hands-off approach rely on normal
market adjustments to remove recessionary gaps.
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The 2020 Pandemic Recession
• The “pandemic recession” of 2020-2021 presented
unique challenges for policymakers in Canada and
elsewhere.
• Applying Economic Concepts 15-3 ‒ explains why
this recession had such unconventional causes and
characteristics and thus why the massive
unemployment during the recession was addressed
with unconventional policies.
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Frictional Unemployment
• Frictional unemployment is inevitable.
• Employment insurance (EI) helps people cope, but
contributes to search unemployment.
• EI program has changed to focus on those in general
need (vs. those who wish to search).
• These changes have contributed to a decline in the
amount of frictional unemployment.
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Structural Unemployment
• Often driven by technological change.
• Likely to increase in the future (due to artificial
intelligence/ automation of jobs).
• Two approaches to reducing structural unemployment:
1. Resist change
2. Assist adjustment
• Policies to increase retraining and to improve the flow
of labour-market information will reduce structural
unemployment (this was addressed in Canada’s federal
government’s 2018 budget).
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Conclusion
• Unemployment: a flawed market system or a
necessary evil?
• Fiscal and monetary policies generally seek to reduce
the most persistent of recessionary gaps.
• Social policies (i.e. employment insurance) seek to
reduce the sting of unemployment
• Countries that succeed in the global marketplace,
while also managing to maintain humane social
welfare systems, will be those that best learn how to
deal with changes in the economic landscape.
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