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Lesson 28: The Unemployment Rate & The Business Cycle

Module 1: Macro Fundamental Analysis

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Video Transcript

in this lesson we’re going to look at the cyclical versus natural unemployment tab and what this is doing this is from the saint louis fed and this data just simply shows the unemployment rate which is the cyclical unemployment rate this is the unemployment rate you will see in the economic calendar when it is released that is the blue line here and the long-term natural rate of unemployment which is the red line and the long-term natural rate of unemployment is just simply as we discussed in previous videos structural and frictional unemployment so it’s just the natural unemployment that would occur in the economy when there are structural changes so people lose their jobs let’s say to robotics and they’re being retrained or just simply people moving between jobs and the time lag between moving jobs or from higher education into work all of that type of unemployment is represented in the natural rate of unemployment this red line and you can see as the cyclical rate of unemployment contracts and expands with the business cycle it oscillates above and below the natural rate of unemployment when the central bank says they are enacting measures to reach their full employment objectives it means they are trying to get employment down to if it’s up in this area unemployment down to the long-term natural rate of unemployment that is what is meant by full employment it’s not zero unemployment it’s the natural rate of long-term unemployment so that would be right here for example would be right here would be at full employment right here the us would be at full employment right here the us would be at full employment right here all the way along this curve where the cyclical unemployment meets the long-term level of unemployment is what is considered as full employment

so you can see you can actually go above the level of full employment or rather below the natural rate of unemployment and when we go below the natural rate of unemployment this is indicative of being at the top of the business cycle you can see when we have very low levels of cyclical unemployment so the unemployment rate is very low here at 2.5 percent it precedes a recession and we have a sharp spike to the upside in unemployment when we come down over in this area it precedes the recession of the 1970s and we have a sharp spike to the upside when we have low unemployment in this area so below the long-term natural rate of unemployment there is a recession over in this area we are below the natural rate of unemployment there is a recession in this area we’re below natural rate of unemployment there is a recession in this area we are quite a way below the natural rate of unemployment this is the top of the business cycle in 2001 this is dot-com bubble and we have this recession you can see it proceeds preceded by very very low levels of unemployment in the cyclical sense and over here in 2008 we are below full employment and this precedes a recession and even recently before the covert 19 crisis you can see that we were at very very low levels of the unemployment rate and this preceded the most recent recession so the same is true on the opposite side when we have very very high levels of unemployment this should be considered as an indication we’re at the bottom of the business cycle and a recovery is due to follow so this is pretty much where we sit right now you can see this is quite severe downturn we had a very sharp one and we were up at levels of almost 15 percent this should now be followed by a gradual recovery and a movement back towards the full level of unemployment so the natural rate of unemployment and this is actually what the stimulus measures from the us government is aimed at is to bring increased growth stimulate growth and then as a derived demand employment will pick up and it will move this all the way back down and when we start to get at some point in the future below the natural rate of unemployment this will once again be a sign that we are just about to enter a recession especially if we’re below this for a sustained period of time now the difficulty always comes especially just before recessions in knowing what the catalyst is it’s easier when you’re in this area to look and say well there’s a very good chance now that we are at the top of the business cycle but you don’t necessarily know what’s gonna what’s going to turn it usually there is a catalyst which turns it like in this in this case for example with the covid 19 virus there’s usually a catalyst when you’re in this area which takes place and that becomes the tipping point which pushes the economy into a recession now the other interesting thing to note here is as the cyclical unemployment rate moves with contractions and expansions in the business cycle and it oscillates above and below long-term unemployment or the natural rate of unemployment this is really what we looked at in previous videos with the long-run aggregate supply curve and also when we looked at the business cycle this was the potential growth or potential output of an economy and either side was when we had actual output of the economy and you can see below when we are actually running below potential so output is less than potential that would be up in this area and when output is above potential that would be down in this area an indication we are actually headed for a recession so this should really be used although this is not a leading indicator the unemployment rate is not a lean indicator this is one of our four coincident macroeconomic objectives that we look at so one of the key metrics of economic performance it can and should be used as a contrarian almost indicator that when levels get very very high when we are in a period of output which is far below potential we should be expecting a recovery and when we are at a period where output is much much higher than potential we should be expecting a call down and we should be expecting a potential recession