Question

how does this definition of the current unemployment problem as cyclical or structural - as well as the appropriate policy response to the current unemployment problem - relate to the way one interprets current economic decisions.

Answer 1

Unemployment is a condition wherein a person willing and able to work is not able to find a job.

Whenever the economy produces its full employment level of output there is still some unemployment, known as the natural rate of unemployment.

There are two types of unemployment: Natural and cyclical.

In natural rate of unemployment there are three sub-types:

a. Structural unemployment.: When economy undergoes a change. Ex. Typewriters are replaced by computers and people need to learn this skill. It may also happen if industry changes location then people in original location will be unemployed. If labor laws are stringent the also it leads to labor market rigidities and industrialists will think of changing job locations.

b. Frictional unemployment.: This occurs when people are in between jobs and if there are jobs but people do not have information about the same.

c. Seasonal unemployment: A tourist guide in hill station during extreme rainy days may be jobless.

In cyclical unemployment, as shown in the diagram below, at point e and below in business cycle jobs are lost as there in no enough economic activity and due to less aggregate demand producers produce less and it leads to unemployment.

Currently unemployment is of structural and cyclical nature. Many countries have rigid labor laws and economies are undergoing recessionary phase as 2008 pressures are still continuing.

To fight with this : demand side policies and supply side policies are used as discussed below:

During an recessionary phase, govt. can adopt expansionary fiscal policy(lowering tax rates and increasing govt. spending) and central bank can have expansionary monetary policy ( lowering interest rates and increasing money supply ).

However, both these policies have policy conflicts. Example to raise economic output expansionary policies may lead to inflation and cause vicious cycle in an economy.

To avoid these conflicts, a solid supply side policies are needed. These policies are of two types- Market based and interventionist based.

In market based- labour market reforms, encouraging competition and creating a business friendly environment is involved. In Interventionist based policy focus is on creating human and physical capital. If this capital is supporting the policies implemented by govt and central bank then policy conflicts can be lowered and long run solid development can be achieved. However, it should be noted that supply side policies are long term ,need time and investments.

Hence if policymakers want to maintain short term employment at highest level and does not want to stress govt. budget then capacity building through supply side policy along with proper combination of monetary and fiscal policies is needs so that economy is kept busy without inflationary impacts.

Along with these policies exchange rate policies like devaluation or revaluation can also be considered. For exports to be promoted and ultimately the manufacturing industry to promote job growth devaluation can be suggested. It helps exports more competitive.