Frictional Unemployment Defined

Almost everyone will go through at least one period of frictional unemployment during their work career. Those people who leave school will generally have to spend a bit of time searching for suitable work. If people work on a contract basis they will tend to have gaps in-between contracts that could also fall into this category of unemployment. Those who have a gap in-between one job and starting the next one can also be described in this way. In many instances people like contract workers will be prepared for this period with no work so it will be no great hardship.

The Benefits of Frictional Unemployment

It is normal for us to consider any period without work to be a bad thing, but frictional unemployment can actually be a good thing. It encourages the individual to find work that is going to be best suited to their needs and skills. This not only benefits them but also benefits society as a whole as it is a mechanism that encourages the best people to end up in the most suitable jobs. It is also good for the employers as it means there is a constant flow of people who are looking for new opportunities. So far from it being a bad thing these periods where people are without work might be crucial for a successful economy.

What Influences Frictional Unemployment?

This type of unemployment is influenced by a number of different factors. The time of year can have a huge impact on the number of people seeking work for the first time. After graduation there will be a whole new cohort of young adults looking for their first opportunities in the business world. The rate of this type of unemployment can also go up depending on location. For example, in rural areas there can be a surge in the number of people looking for work during the winter; this is when there is less to do on the land.

Frictional unemployment is also influenced by structural unemployment. There can often be a difference in the number of people who want to work in a certain industry and the number of job opportunities available. A good example of this is the construction industry where a slowdown can leave a lot of people desperate to find any type of work. Structural unemployment can be particularly hard to deal with and it may force people to retrain so as to get work in a completely different industry.

A Closer Look at Cyclical Unemployment and the Business Cycle

The reason why we refer to this as cyclical unemployment is that it is directly linked to the business cycle. When business is good there is less unemployment but when things get tough for businesses then unemployment goes on the rise. The term, ‘business cycle’ can be a bit misleading because it suggests that it is predictable. In fact this cycle can be very unpredictable and this is why sudden mass unemployment can come as a shock. For instance the downturn after the economic crash a few years ago caught most people by surprise.

Although the business cycle is not exactly predictable it is said to have four stages. At the beginning of the business cycle there is a slowdown in the economy and this leads to a situation referred to as contraction. Eventually the slowdown causes the economy to reach its lowest point and this is the second stage of the business cycle. At this second stage unemployment will be at its lowest. Next the economy will begin to expand again and employment opportunities will increase. The fourth stage is the peak and here unemployment is at its lowest. When this peak is reached it can occur that there are more jobs available then there are people to fill them. Unfortunately the only place to go after a peak is down.

Another way to look at cyclical unemployment is to view it as a negative correlation between the employment rate and GDP. As consumer demand falls it leads to a situation where unemployment increases. The fall in employment levels will lead to even less consumer demand. This can lead to a downward spiral that causes a lot of problems within the economy.

Cyclical Unemployment and Depressions

The business cycle is said to usually revolve quite quickly. This should mean then that periods of a lot of unemployment shouldn’t last very long. Unfortunately this isn’t always the case and sometimes we hit a long period of mass unemployment referred to as a depression. This type of situation is caused by a number of different factors and it can keep the economy in trouble for many years. During this time unemployment becomes a huge problem and it is often necessary for governments to step in. The usual way to do this is by investing in big projects or other Keynesian type solutions. The government might also use incentives such as lower taxes to stimulate the economy.

What is Inflation?

In its basic terms inflation refers to the situation when prices rise thus creating a condition whereby the purchasing power of those in a society falls. If you are earning an x amount every month you will be able to buy a certain number of products, but if the prices of these products goes up you will be able to buy less out of your earnings. Economists will have pre-determined numbers in mind for the overall price of products and if there is an increase beyond these percentages the situation will be described as inflation.

Inflation is usually viewed negatively and there can be a sense of panic when it gets out of hand. Governments around the world are always taking measures to control inflation. If inflation is allowed to take hold it can mean that wages need to rise, and this will further increase the price of products. Inflation will mean that a country’s exports become less competitive abroad as they are now worth less than they used to be. Uncontrolled inflation makes it hard for everyone to plan for the future, and there may be a sense of doom.

What Causes Inflation?

There have been a number of different factors which have been blamed for causing inflation including:

• Demand pull is a situation where inflation has been caused due to the government producing too much money. The government may be trying to stimulate the economy by injecting a lot of money; perhaps by increasing their spending on social services. This sudden extra money then causes the prices of things to rise to keep up with the increase.
• An increase in the cost of production will also lead to inflation. If it costs more to buy materials or workers demand higher wages this can lead to the final cost of products increasing in order to make up the loss. This means that while workers might benefit from higher wages they will later lose out because they are paying more as customers.
• If a government raises taxes too high this may also lead to inflation as the business owners attempt to pass on the increase to their customers.
• If the country has a lot of debt then this could also lead to a situation of inflation as it can lead to a situation where public services need to increase in price.
• An unfavorable foreign exchange rate can also lead to a situation where inflation takes hold.

Keynesian Economics

A lot of Keynes’ more well known ideas developed as an attempt to provide solutions for the Great Depression. He starts with the assumption that there is a circular flow of money. When one person spends money it becomes another person’s earnings; this person in turn spends the money they get and it becomes another person’s earnings and so on. This circular flow of money is the normal state of affairs and it benefits all the participants. Sometimes things can go wrong and this will stop this process; if the economic climate looks bad then this will likely mean a lot of people will be afraid to spend their money. If people are hoarding their money then this is going to mean that other people aren’t earning and the circular flow of money becomes difficult and this leads to the economy failing.

Keynes believed that it was possible to rectify these difficulties with the circular flow of money by what he called ‘priming the pump’. If people are afraid to spend then the government needs to step in and get things going again. One of the famous suggestions associated with Keynesian Economics is that even paying people to dig holes and fill them in again could be a way to stimulate the economy. Keynes believed that the best approach that a government should take would be either to buy things or increase the supply of money. The idea is that you can spend your way out of an economic depression because it once again fires up circular flow of money.

Criticisms of Keynesian Economics

Keynes was a firm believer in the idea that the government should interfere with the economy. In fact he claimed that the free market just wasn’t capable of functioning appropriately without intervention. These ideas are quite different from Laissez-fair capitalism which is the other hugely influential economic school of thought that has great influence in today’s world. According to supporters of Laissez-fair capitalism the government should keep away from the economy because the interference will always lead to negative outcomes – the idea is that the economy will sort itself out so long as it is left alone. In the United States there is a lot of support for this non-intervention approach as concerns about government bailouts increase.

Even those economists who don’t agree with John Maynard Keynes will agree that his ideas have had a huge impact on our modern world. He is credited for inspiring many of the social programs that blossomed in Europe and the US during the twentieth century.

What is Inflation?

In economics inflation is used to describe a rise in the cost of goods and services over time. You may have noticed that some things tend to be a lot more expensive these days than they were a decade ago. Back in the eighties you could buy a couple of pints of beer for a quid, but now you would be lucky to get change from ten pounds. The reason for this rise in price is inflation. Most things will rise in price over time and this can lower the purchasing power of our income; this is why there are often demands for pay raises to keep in pace with this inflation. Sometimes inflation can get completely out of control; after the Second World War you needed a wheelbarrow full of German Currency to buy a loaf of bread there – this is called hyperinflation.

Why is Inflation Bad?

You might wonder why inflation is considered such a bad thing. After all, so long as our wages keep on going up then surely it isn’t going to make that much difference. The fact is though that inflation can have many negative consequences if it gets out of hand; here are just some of the negative consequences of inflation:

• When the prices of things rise it can make them less appealing to customers. Sales will fall and this will have a knock on effect of causing businesses to fail. When these businesses fail it will lead to unemployment and people will have even less money to spend on products – it becomes a vicious circle.
• When prices go up it means that workers will demand higher pay from their bosses. Providing higher pay can take a huge chunk out of profits and discouraged entrepreneurship. Investors are not going to risk their capital if they don’t think there is a good profit to be made.
• When inflation isn’t tightly controlled it tends to mean that a country will get into a ‘boom and bust’ cycle.
• If entrepreneurs are uncertain about where the economy is going they will be less likely to take risks and expand.
• When inflation is high a lot of people will cut back on their spending in the hope that prices will fall again later – this can lead to all types of problems.

As well as there being many negative consequences of inflation there can also be some positive effects. It might mean that overall debt is lowered because the real value of these debts won’t be as much. Generally speaking though, most experts agree that too much inflation is a bad thing and should be kept in check.

Concise Guide to Macroeconomics: What Managers, Executives, and Students Need to Know by David A. Moss (2007)

This short book is probably suitable for almost anyone who wants an introduction to macroeconomics. It covers the most important topics and can be read from cover to cover without too much hardship; by the time you are finished you should have a fairly good overview of the subject. Many people use this book as a basis for information and then build upon this with other texts.

Macroeconomics Demystified by August Swanenberg (2005)

This is another good introductory text that will give you a firm basis in the subject. The information is easy to understand and presented in a way that is likely to be remembered. There is a lot of confusing ideas in macroeconomics but this text aims to demystify the whole thing.

Macroeconomics by David Colandar – 8th Edition (2009)

This book is aimed at the undergraduate student first encountering the subject but would likely be useful to most people who want to learn about the subject. The style of writing is light but there is enough information to get a good grasp of most macroeconomic topics.

Macroeconomics: A Contemporary Introduction by William A. McEachern – 8th Edition (2008)

This book focuses on macroeconomics in the modern world. It takes examples from what is happening now and uses this to delve into macroeconomic theory. The fact that the examples are taking from the world around us, means that it is more likely that students will be able to appreciate what it is all about. This book would like be of benefit to people who are studying the subject at university or just want to understand the world a bit better.

Study Guide for Macroeconomics by Paul Krugman, Robin Wells, and Elizabeth Kelly – 2nd Edition (2009)

This book has been created to help those studying for an exam on macroeconomics but the the simple way that everything is laid out makes it a good reference as well. All the basics of the main theories are there and this is the type of book that it would be handy to have in your bookcase.

What is the Business Cycle?

The business cycle is also sometimes referred to as the economic cycle. It is concerned with the fluctuations that occur in an economy over a period of time.  The economic cycle typically occurs over a few years and will involve a period of rapid economic growth after which things slow down and then growth declines. The term ‘business cycle’ would seem to suggest that this process is predictable and constant but this is not the case; in fact these business cycles can be very unpredictable.  One of the main ways that a country’s business cycle is tracked is through observing changes in GDP.

The business cycle is often said to go through four stages; expansion, peak, contraction, and trough. During expansion there is an increase in the amount of economic activity occurring in a country and this continues until the peak of activity is reached. After the peak the economy begins to go through a period of contraction and economic activity begins to slow down; this continues until the trough where the bottom of the cycle is reached and economic activity once again begins to expand. This business cycle is a fair representation of what occurs in economies but it is important to keep in mind that the real world is a lot more complicated and these cycles can really be unpredictable.

What Causes a Business Cycle?

There are complex reasons for why the business cycle occurs but it can be explained in quite a simple manner as well. As an economy expands it and there is rapid economic growth it almost always leads to inflation and things just become more expensive to buy. The rising costs cause industry to slow down their growth and this leads to the economic contraction. This is why governments often apply a lot of effort to controlling inflation because it is that that often precipitates and economic slowdown.

The business cycle is a useful theory and helps people understand what is occurring in economies around the world. It should be remembered though that when it comes to the real world that economies will not follow a predictable cycle.

Keynesian economics refers to a theory created by British economist John Maynard Keynes. He believed that the government needed to play an important role in any economy if it was to be successful. One of his most famous suggestions was that paying people to dig holes and just fill them again could be good for the economy. Keynes found all economic theory before his time to be lacking and he believed that the free market could never lead to full employment without attempts to influence it. He was a firm advocate of a mixed economy where there would be a public and private sector; the UK has been greatly influenced by his ideas.

Keynesian economics is viewed as offering a happy medium between Communism and Capitalism. It provides justifications as to why the government should be allowed to interfere with markets. For instance a Keynesian would argue that it would be possible for the Government to spend their way out of a recession by investing a lot of money in public projects. It is believed that investing money in this way can really get a stagnant economy moving again. An example of this would be paying people to build council houses; they will use their pay checks to buy other products and services and there will be a knock on effect that benefits the whole economy.

Those economists who believe fully in the power of the free-market would strongly object to the ideas within Keynesian economics. They would view any attempt of governments to interfere in the market as bad, and that left to its own devices the market will always right itself without any need to meddle. This is in opposition to Keynesian theory which claims that the free market is inherently flawed.

Although there is much debate as to the relevancy of Keynesian theory there is no doubting the impact that it has had on the world. It is almost certain to be debated for a long time to come, and it will continue to influence economic decisions that governments make.

Economists do not agree and there are two competing explanations. The first is that the world is anticipating a sharp inflation. This is because governments are creating a large amount of paper money as a result of the “Quantitative Easing” programs. This is the way that central banks are trying to stave off depression by creating money and using the vast majority of the money to buy government bonds which in turn drives down interest rates. This has not, yet, led to an increase in prices. This is because firms and consumers are saving and this slows down the speed of money. Once people start spending again then they will have much more money to spend and prices will go up. Gold is simply anticipating a great inflations and the gold price will either stay more or less where it is or go even higher.

Another school say that the market is simply sticking with what seems solid. Money, stocks and corporate bonds have been a poor store of value. Gold is a safe haven, which is guaranteed to keep some of its value. When the market returns to normal there will be no need for a safe haven and the gold price will gently deflate.

At the moment the gold price is at a historic high to the dollar. Gold mining output is actually declining, although there is plenty of exploration for gold and old mines can be bought into production. Similarly consumers selling jewelery to be melted down seems to have peaked.

In the end no-one knows where the gold price is likely to go. So far it seems to have defied gravity for a long time, and if we had to call it we’d say that won’t last.

The money is used to buy assets from banks and other big financial institutions, usually government bonds. The idea is that the banks that hold these bonds are now able to lend this money on to businesses and individuals. This is not what is happening. Banks are mostly hoarding the money that they are getting from selling government bonds in case they have further claims on their reserves.

Money is still getting in the system. Despite unprecedented (at least in living memory) worries about government solvency bond yields are down rather than up as all the money goes almost directly into buying bonds. This has meant that investors are getting tiny amounts of money for putting their money into government bonds, and so putting their money elsewhere. It also means that governments can borrow despite a collapse in the amount of tax they collect, and so keep spending at a very high level.

Is this causing inflation? It really depends what you mean when you say inflation. There are two definitions of inflation. The first is inflation in the sense of a tire being filled with air, it is the process of the air coming (and staying) in rather than the process of the tire rising that is the inflation. So with money. Inflation is simply money coming and staying in the system. By this definition Quantitative Easing is inflation, not a cause of it.

The more common meaning of inflation is that of a general price rise. Prices on their own rise and fall to reflect the factors of supply and demand. Prices in general will neither rise nor fall if the money in the system is the same, and it is going at the same speed. Well the money is definitely not the same, so prices should be rising, but they are not rising, or not as much as they used to when there was much less money being poured into the system. The problem is the speed rather than the quantity. The speed is known to economists as velocity. If the velocity is slower then there is in effect less money in the system as it is not being spent. If the money is simply going into bank accounts then it is in effect being withdrawn from the system.

So is Quantitative Easing causing inflation? Some people say that it’s counter balancing deflation as banks would hang on to money just as much as they would have if Quantitative Easing was not in place. If you aren’t seeing enormous inflation, they argue, you are also not seeing enormous deflation. Some also claim that rising prices will happen, just not yet. There’s a wall of money that is sitting on the sidelines. Sure, it’s not around at the moment, but when the velocity picks up then we’ll see it, in shop prices.