Unemployment refers to the phenomenon of people who do not have jobs but would like to have one.  Many people associate unemployment with bad economic times.  But, even in the best of times, an economy is likely to experience unemployment rates (i.e. the percentage of the labor force without a job) of 4% or more.  You can verify this claim in the interactive graphic below, which plots unemployment rates from 1960-2015 across a variety of countries (recession dates are shaded in blue).

There are several distinguishing features to the unemployment data in the graph.

  • There is substantial variation in the unemployment rate over time.  
  • Unemployment rates increase during recessions.  The shaded blue lines are periods of recession in a country.  You can see that when an economy enters into a recession, the unemployment rate increases.
  • Unemployment rates decrease during recoveries from recession.  Shortly after a recession, unemployment hits a peak, and then begins a (gradual) recovery.  
  • Therefore, unemployment is a counter-cyclical predictor: it goes up as the economy does poorly, and it goes down as the economy performs well.
  • There is always unemployment.  You can see that as the economy recovers, and before it enters another recession, unemployment bottoms out at a value that is above zero.  In fact, it is rare for the U.S. economy to experience unemployment rates below 4%.
  • The lowest observed unemployment rate in a  recovery varies over time.  For the U.S. you can see that sometimes the unemployment rate bottoms out at about 4% and other times as high as 6%.

These observations lead economists to differentiate between

  1. cyclical unemployment -- i.e. unemployment experienced during a recession; and,
  2. the natural rate of unemployment -- i.e. unemployment one would expect if the economy were not in a recession.

This chapter covers reasons why an economy always experiences some unemployment, which we call the natural rate of unemployment.  In another chapter, we explore the reasons why cyclical unemployment may arise.  

Confusion Alert: macroeconomists historically like to think that they can clearly distinguish between the two types of unemployment.  New research in macroeconomics -- reinforced by the prolonged period of unemployment experienced following the Great Recession (2007-2009) -- suggests that the two concepts may be closely intertwined.  The end of this chapter discusses this possible confusion, but first we need to define the natural rate of unemployment.

Calculating the Unemployment Rate

The U.S. Bureau of Labor Statistics (BLS) calculates the unemployment rate for the U.S.  They derive their calculations from the Current Population Survey, a monthly survey of households.  They include in their survey all people 16 or older, currently living in one of the 50 states or Washington D.C., and are not in an institution (e.g. prison, mental facility, or an assisted living home) or the armed forces. During the survey they ask each household about their employment status, and then place them into three broad categories:

  • Have a job, full or part time, with an employer or self-employed: are counted as Employed.
  • Do not have a job but are actively looking for one: are counted as Unemployed.
  • Do not have a job and are not actively looking for one: are counted as Not in the Labor Force.

The unemployment rate is defined as follows.

Definition. The unemployment rate is the percentage of the labor force that is unemployed.

From the survey, the BLS calculates \( E\), the number of employed workers, \( U\) the number of unemployed workers, the \(LF\) number of workers in the labor force, and \( NLF\) the number of people not in the labor force.  Then, they can calculate $$ LF=E+U,$$ that is, the labor force consists of all people with jobs or without jobs but are looking for jobs.  An important point: a worker that would like a job but has given up looking is counted as not in the labor force.  Similarly, retired workers, full time students, people who work full time taking care of a family or household, are not counted as in the labor force.  

The unemployment rate then is $$ u=\frac{U}{E+U}=\frac{U}{LF}$$. Sometimes, we also discuss the employment-population ratio $$ e=\frac{E}{LF+NLF}$$ and the labor force participation rate $$ l.f.p.r.=\frac{LF}{LF+NLF}$$. The interactive graphic below shows how these latter two labor market indicators -- the employment-population ratio and the labor force participation rate -- have varied over time in the U.S.


A few observations:

  • The employment-population ratio exhibits similar behavior over time as the unemployment rate, except that it is a cyclical indicator: the employment rate decreases during recessions and increases during recoveries.  
  • The labor force participation rate is driven much more by demographic trends.  In the graph, the labor force participation rate experienced a long increasing trend until about 2000 and then a downward trend.  The labor force participation rate decreases somewhat during a recession, but it is not typically as volatile as the unemployment or employment rates.
  • The increasing trend in the labor force participation rate and the employment-population ratio from 1960-2000 was driven primarily by women entering the labor force.  That flow of women into the labor force peaked in 2000, and somewhat puzzlingly was that roughly at the same time the labor force participation rate of older men began to decline in 2000.  This accounts for the trends seen in the two pictures.
  • The Great Recession had profound and lasting effects on the population ratio and the labor force participation rates.  The labor force participation rate declined from 67% to 63%, and has not recovered, since the start of the 2007-2009 recession.  The employment rate dropped precipitously from 63% to about  58%, remained depressed for a number of years, and only recently has started a slight recovery.
  • Some of the declines in the labor force participation rate and employment rate since the Great Recession is just accelerating the declining trend seen before 2007 as more and more of the Baby Boom generation hits retirement age.  Some of the abrupt decline is from discouraged workers, i.e. workers who have been unemployed for a long period of time, become discouraged about their job prospects, quit looking for work, and exit the labor force.  There is concern among economists that these long-term unemployed workers may be permanently affected by the recession as their human capital skills may have eroded during the prolonged unemployment spell.  Finally, the labor force participation rate of 16-25 year olds dropped during the Great Recession and has not recovered much.  Many of these workers have exited the labor force to remain in school longer.

Why is Unemployment an Important Issue?

Economists, politicians, and other policymakers (especially at the Federal Reserve) spend quite a bit of time worrying or debating about the causes and consequences of unemployment.  So, it is natural to ask why unemployment is an important issue worth our efforts to learn about it?

Recall the chapter on explaining the size of the long-run economy.  How much an economy can produce determines its living standards.  Moreover, output or income are determined by the production function $$ Y=AF(K,L,H,N)$$ Clearly, the amount of labor is an important input into the production process.  An economy with a substantial unemployment rate, therefore, is not employing all of its inputs and so is unable to reach its maximum sustainable income and output.  It follows that an economy can increase its overall standards of living if it can make its labor markets more efficient at employing its labor force.