MACROECONOMICS I May 23rd, 2014 Class 12. The Labor Market • Final Exam: May 30th, 10:30 – 12:30, S6 Closed-book exam; bring your calculator!!! • Project deadline: May 30th, before exam, hard copy Project checklist: ü Summary of the article (main issue) ü Placing the issue in the context of our course ü General theory behind the issue ü Your opinion about the article and the issue NO more than 4 pages ! Announcements Goals of the Economy •Economic growth •External balance (avoiding trade deficit) •Price-level stability (low inflation) •Low unemployment rate (full employment) Conflicting goals in the short run Inflation in Selected Countries Source: OECD statistical database Real Exchange Rate • Nominal ER: Amount of national currency you pay for a unit of foreign currency • Real ER: Relative price of foreign goods to domestic goods at the prevailing exchange rate (competitiveness) A rate at which we can trade goods and services of one country for that of another Measuring RER • Using a simple representative good • Using the overall price level • w/r to a single country or all trading partners Real Exchange Rate (Cont.) TE Price of McDonalds’ hamburger in CR is 35 CZK Price of McDonalds’ hamburger in Vienna is 1 Euro • Comparing prices of hamburgers: converting into common currency Nominal exchange rate: 1 euro = 27 CZK Price of Austrian hamburger (in CZK) = 1 * 27 = 27 CZK Price of Czech hamburger = 35 CZK RER = 27/35 = 0.77 => Hamburgers in Austria are 30 % cheaper than in CR (when expressed in the same currency) Real Exchange Rate (Cont.) • Measuring RER using a basket of representative goods Price level in Czech Republic (P) Price level in Austria (P*) Nominal exchange rate: 1 euro = 27 CZK Real ER = Nominal ER ∙ P* / P • P and P* represent CPI or GDP Deflator price indexes How expensive, on average, foreign goods are relative to domestic RER = 1.2 => average consumer prices abroad are 20 % higher than at home, relative to a chosen benchmark Real Exchange Rate (Cont.) ü What is the value of RER if the PPP holds? • When RER diverge from PPP, the nominal exchange rate experiences pressure to adjust § Three determinants: P, P* and nominal ER A real exchange rate appreciation and depreciation Overvalued currencies (RER<1) => pressure to depreciate Undervalues currencies (RER>1) => pressure to appreciate Source: FED statistics Causes of Inflation ü Demand-pull inflation ü Cost-push inflation ü Increase in MS Increase in aggregate demand (through inputs market) Increase in the costs of production independent of demand MS growth faster than Y “Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.” M. Freedman Short Run vs. Long Run § Quantity Theory of Money § § § § In the long run: • Real output (Y) is determined by available L, K, and A • Velocity is constant (empirical fact) Þ Increase in MS leads only to an increase in P Money neutrality: changes in MS do not affect REAL variables Empirical tests: long-run + across countries > Average Inflation Rates & Money Supply Growth Source: Mankiw, 2012 The Quantity Theory in the US Across Time AD-AS Model: The Equilibrium Equilibrium: Y* and P* Costs of Inflation • Fall in the real value of savings • Fall in net exports • Fall in investment expenditures • Fall in GDP • Increase in unemployment • Redistribution of real income (decreasing liabilities of debtors and assets of creditors in real terms) • Loss of the purchasing power? => Money neutrality The Labor Market: Major Players Firms Labor Force • Working age 15-65 • Employed + Unemployed • Non-institutionalized Labor Wages Government • Minimum wage • Unemployment insurance • Training programs Labor unions •Wage bargaining •Protection of rights DEMAND SUPPLY Structure of the Labor Force Working-age population Labor Force Employed Unemployed Participation rate: TE Participation rate in Czech Republic in 2012 was 58.8 % Males: 67.8 % Females: 50.1 % Out of Labor Force • Retirees • Stay-home mothers • Students • Institutionalized • Military • Discouraged Structure of the Labor Force (Cont.) TE Czech Republic in 2005 Total population: 10.2 mil Working age population: 70.5 % Out of labor force: 3.5 mil Working age population (mil): Labor force (mil): Participation rate: Labor Force: Unemployed Population Unemployment rate: Percentage of the labor force not working but looking Can the unemployment rate be equal to 0? Generally NO • A person without a job who puts efforts to find one • A summary measure of the health of the labor market Low unemployment rate => Tight labor market Unemployment Rate (Cont.) Active or stagnant labor market? • Average duration of unemployment and its type Unemployment Rate Limitations • Underemployment (skill waste) • Does not say anything about unemployment duration Long-term unemployment – more than 1 year • Does not distinguish between full-time and part-time employment • Very difficult to distinguish between unemployed and those out of labor force Discouraged workers: people who report being out of labor force, but in fact may be willing to work (gave up after unsuccessful search) Unemployment and Long-Term Unemployment Rates • Average for the period 1991-2001 Average duration of unemployment in 2012 • The US – 5 month (the lowest!) • EU – 27 months • France – 40 month • Czech Republic – 12 months • Slovakia – 26 months Source: OECD.StatExtracts Long-Term Unempl. as a % of the Total Unemployment Measuring Labor TE In the US: Bureau of Labor Statistics (BLS) Current Population Survey (monthly): 60,000 households • People who are working • People who are not working but looking • People who are not working and not looking (out of labor force) • In Czech Republic: National Statistical Office (CZSO) Quarterly Labor Force Sample Survey: 26,500 households Categories of Unemployment § Short term 1.Frictional Unemployment • Qualified individuals with transferable skills that move between jobs/careers • Outcome of the labor market turnover • A sign of healthy economy • It takes time for workers to find jobs that are best suited for them Why there is unemployment in the economy? Special case: Seasonal unemployment: move b/w jobs that change with seasons • Increases with an increase in unemployment benefits Unemployment Insurance Country Initial phase of unemployment Long-term unemployment Single person Married with 2 children Single person Married with 2 children Czech Republic 50 54 31 71 France 71 76 41 70 Germany 61 78 61 68 Greece 46 50 0 3 Italy 52 60 0 0 Netherlands 71 78 58 72 Norway 66 73 42 64 Slovak Republic 62 72 42 91 Spain 70 75 27 41 Sweden 81 83 51 78 UK 45 46 45 73 USA 56 53 7 41 Average duration • 1 year in general • 4-5 years in Netherlands and Denmark • Unlimited in Belgium Duration of Unemployment Benefits (in weeks), 2010 Categories of Unemployment (Cont.) § Long term 2. Structural Unemployment- changes in the technology and foreign competition • A whole industry dies • A mismatch between necessary skills and skills of the labor force • A sign of innovative society TE NAFTA • Back to school (re-training) 3. Cyclical Unemployment - follows the business cycle • Economic contractions • Difficult to predict when jobs would come back (all cycles are different) Business Cycle and Unemployment Ump. Rate TE The US Unemployment rate during 1948-2008 Source: Mankiw, 2012 Recession of 2007-2009 Source: Pissarides, 2012 Recession of 2007-2009 Source: Pissarides, 2012 Source: Pissarides, 2012 Recession of 2007-2009 • Unemployment rate when the business cycle component is eliminated • Only frictional and structural unemployment • Always positive in dynamic economies, when the free movement of labor is allowed => Full employment => Potential GDP § Natural Rate of Unemployment • Government unemployment insurance More generous benefits => Higher natural rate Determinants • Demographics Older labor force => Less frictions => Lower natural rate • Wage rigidity: Minimum-wage laws • Efficiency wage Natural Rate of Unemployment , the USA 5 % Minimum Wage § Wage rigidity – the failure of wages to adjust to the equilibrium level Objective: Rising the income of working poor Major criticism: Increases unemployment • Causes teenagers to drop out of school • Prevent low skilled workers from the participation in training programs •A legal minimum on wages set by the law • In the range of 30-50% of the average wage in manufacturing Gross minimum wages Euros per month, 2012 Source: Labor Supply and Labor Demand Aggregate supply: the sum of individuals’ labor supply Extensive margin: Whether or not participate in the labor market? Intensive margin: For participants, how many hours of labor to supply • Most variations in labor supply is due the extensive margin (new entries) Two goods: Consumption and leisure • Wage is the opportunity cost of leisure Reservation wage – the wage such that the agent participates in the labor market • At the reservation wage workers are indifferent b/w staying on the job or leaving A famous supermodel once said that she would not get out of bed for less than $10 000 (presumably per day) Labor Demand: maximization of profits/ minimization of costs The Labor Market: Equilibrium Hourly wage, W Labor hours , Q Minimum wage N!B! Minimum wage results in the unemployment increase • Different markets for different skills types • The most affected are the least skilled whom the policy is intended to help Unemployment Increase in Minimum Wage Assume the government raises the minimum wage. • What does this do to the natural rate of unemployment? • Do these effects arise by changing the amount of frictional unemployment or by changing the amount of structural unemployment? Unionization • Organization of workers in some industry that bargains with firms about wages and working conditions • The wages of union workers are determined by the bargaining between union leaders and firm management Þ Higher than equilibrium wages Wage effect • Union status increases wages of workers by 10-20 % • Outsiders are hurt by low fewer job offerings The Importance of Labor Unions Source: Mankiw, 2009 The Role of Labor Unions (Cont.) 1.Unions in the US have become considerably weaker and less prevalent since the 1950s. What did this do to the natural rate of unemployment? 2. Did these effects arise by changing the amount of frictional unemployment or by changing the amount of structural unemployment? Wage Distortion: Efficiency Wage • Improve workers productivity and effort • Reduce labor turn-over • Improves average quality of the firm’s work force TE Ford Motor Company • In 1914 the company started paying workers $5 per day “We wanted to pay these wages so that business would be on a lasting foundation… The payment of $5 per day was one of the finest costs cutting mover we ever made” Henry Ford American vs. European Labor Markets Annual hours worker per person Source: Mankiw, 2009 Happiness by Working Hours in the US and Europe Source: Okulicz-Kozaryn, 2013 Inflation and Unemployment • A trade-off: in the short run, inflation and unemployment move in opposite directions • Empirical finding for the UK data 1861-1957 • Expansionary policy => Lower unemployment & Higher inflation § Phillips curve • Fighting inflation with contractionary monetary policy’ MS => AD => Y => U Inflation rate (%) Unemployment rate Inflation Targeting Monetary policy is tailored with a focus on inflation ÞLong-term goal for inflation (inflation target) Target values: 2 % values for developed economies and 4 % for emerging Price stability + Maximum employment Why inflation target is not 0? => Benefits of inflation ü Reduce probability of falling into deflation ü Heating lower zero bound ü Downward nominal rigidities in factor prices Critique: Shifting focus from other macroeconomic goals Benefits of Positive Inflation 1.“Greasing the wheels of the economy” •People dislike nominal wage cuts •If inflation is positive, real wages decline •People quite jobs rather than accept wage cuts => increase in unemployment •Keeping inflation positive allows to eliminate this type of unemployment 2. Some inflation can may monetary policy easier •