Measuring Unemployment and Inflation

Measuring unemployment

To be counted as unemployed a person must be of working age, without a job, available for work and actively seeking work. The labour force is the employed plus the unemployed, and it deliberately excludes discouraged workers — people who want a job but have stopped searching because they believe none is available.

Two further indicators are needed because the headline rate hides so much:

• Labour force participation rate $=\dfrac{\text{labour force}}{\text{working-age population}}\times100$ — it reveals whether a falling unemployment rate came from new jobs or from people giving up.
• Underemployment (hidden unemployment) — part-time workers who want full-time hours, and graduates working far below their qualifications. Neither appears in the unemployment rate at all.

Types of unemployment

• Frictional — short gaps while workers move between jobs. Normal, and a sign of a flexible market.
• Structural — a permanent mismatch between the skills or location of workers and the jobs available, caused by technological change, trade or the decline of an industry. The hardest to cure.
• Seasonal — predictable annual patterns in tourism, agriculture or construction.
• Cyclical (demand-deficient) — caused by a fall in aggregate demand during a recession. This is the only type demand-side policy can remove.

The natural rate of unemployment is frictional plus structural plus seasonal. At full employment cyclical unemployment is zero but the natural rate remains, so full employment never means $0\%$.

Measuring inflation

Inflation is a sustained rise in the general price level; disinflation is a fall in the rate of inflation while prices still rise; deflation is a fall in the price level itself. The CPI is a weighted index of a fixed basket, where each category's weight reflects its share of household spending:

Core inflation strips out food and energy, whose prices are volatile and often driven by world markets rather than domestic demand, so central banks watch it when setting policy.

Causes and costs

Demand-pull inflation comes from AD shifting right; cost-push inflation comes from SRAS shifting left, and it raises the price level while output falls — stagflation. Inflation erodes savings and real incomes, creates menu and shoe-leather costs, redistributes from lenders to borrowers, and damages international competitiveness. Deflation is often worse: households postpone purchases expecting lower prices, the real burden of debt rises, and nominal interest rates cannot fall below roughly zero.

(HL) The Phillips curve

The short-run Phillips curve shows an inverse relationship between inflation and unemployment. The long-run Phillips curve is vertical at the NAIRU — the non-accelerating inflation rate of unemployment. Once expected inflation adjusts, the SRPC shifts outwards and unemployment returns to the NAIRU at a permanently higher inflation rate.