In demand-based theory, it is possible to abolish cyclical unemployment by increasing the aggregate demand for products and workers. However, eventually the economy hits an “inflation barrier” imposed by the four other kinds of unemployment to the extent that they exist.
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Some demand theory economists see the inflation barrier as corresponding to the natural rate of unemployment. The “natural” rate of unemployment is defined as the rate of unemployment that exists when the labour market is in equilibrium and there is pressure for neither rising inflation rates nor falling inflation rates. An alternative technical term for this rate is the NAIRU or the Non-Accelerating Inflation Rate of Unemployment.
No matter what its name, demand theory holds that this means that if the unemployment rate gets “too low,” inflation will get worse and worse (accelerate) in the absence of wage and price controls (incomes policies).
One of the major problems with the NAIRU theory is that no one knows exactly what the NAIRU is (while it clearly changes over time). The margin of error can be quite high relative to the actual unemployment rate, making it hard to use the NAIRU in policy-making.
Another, normative, definition of full employment might be called the ideal unemployment rate. It would exclude all types of unemployment that represent forms of inefficiency. However, it would be impossible to attain this full-employment target using only demand-side Keynesian stimulus without getting below the NAIRU and suffering from accelerating inflation (absent incomes policies). Training programs aimed at fighting structural unemployment would help here.
Short-Run Phillips curve before and after Expansionary Policy, with Long-Run Phillips Curve (NAIRU)
Costs of Increasing Unemployment Rate:
Unemployed individuals are unable to earn money to meet financial obligations. Failure to pay mortgage payments or to pay rent may lead to homelessness through foreclosure or eviction. Across the United States the growing ranks of people made homeless in the foreclosure crisis are generating tent cities. Unemployment increases susceptibility to malnutrition, illness, mental stress, and loss of self-esteem, leading to depression. According to a study published in Social Indicator Research, even those who tend to be optimistic find it difficult to look on the bright side of things when unemployed. Using interviews and data from German participants aged 16 to 94 ââ‚¬” including individuals coping with the stresses of real life and not just a volunteering student population ââ‚¬” the researchers determined that even optimists struggled with being unemployed.
An economy with high unemployment is not using all of the resources, specifically labour, available to it. However, there is a trade-off between economic efficiency and unemployment: if the frictionally unemployed accepted the first job they were offered, they would be likely to be operating at below their skill level, reducing the economy’s efficiency.
High levels of unemployment can be causes of civil unrest, in some cases leading to revolution, and particularly totalitarianism.
Benefits of Increasing Unemployment Rate
Unemployment may have advantages as well as disadvantages for the overall economy. Notably, it may help avert inflation, which is argued to have damaging effects, by providing a reserve army of labour, which keeps wages in check.
However the direct connection between full local employment and local inflation has been disputed by some due to the recent increase in international trade that supplies low-priced goods even while local employment rates rise to full employment.
The inflation-fighting benefits to the entire economy arising from a presumed optimum level of unemployment has been studied extensively. Before current levels of world trade were developed, unemployment was demonstrated to reduce inflation, following the Phillips curve, or to decelerate inflation, following the NAIRU/natural rate of unemployment theory, since it is relatively easy to seek a new job without losing one’s current one. And when more jobs are available for fewer workers (lower unemployment), it may allow workers to find the jobs that better fit their tastes, talents, and needs.
As in the Marxist theory of unemployment, special interests may also benefit: some employers may expect that employees with no fear of losing their jobs will not work as hard, or will demand increased wages and benefit. According to this theory, unemployment may promote general labour productivity and profitability by increasing employers’ monophony-like power (and profits).
Optimal unemployment has also been defended as an environmental tool to break the constantly accelerated growth of the GDP to maintain levels sustainable in the context of resource constraints and environmental impacts. However the tool of denying jobs to willing workers seems a blunt instrument for conserving resources and the environmentââ‚¬”it reduces the consumption of the unemployed across the board, and only in the short term.
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Full employment of the unemployed workforce, all focused toward the goal of developing more environmentally efficient methods for production and consumption might provide a more significant and lasting cumulative environmental benefit and reduced resource consumption. If so the future economy and workforce would benefit from the resultant structural increases in the sustainable level of GDP growth.
Good Policies to Reduce Unemployment
Societies try a number of different measures to get as many people as possible into work, and various societies have experienced close to full employment for extended periods,.
However, mainstream economic discussions of full employment since the 1970s suggest that attempts to reduce the level of unemployment below the natural rate of unemployment will fail, resulting only in less output and more inflation.
Many countries aid the unemployed through social welfare programs. These unemployment benefits include unemployment insurance, unemployment compensation welfare and subsidies to aid in retraining. The main goal of these programs is to alleviate short-term hardships and, more importantly, to allow workers more time to search for a job.
A direct demand-side solution to unemployment is government-funded employment of the able-bodied poor. This was notably implemented in Britain from the 17th century until 1948 in the institution of the work house, which provided jobs for the unemployed with harsh conditions and poor wages to dissuade their use. A modern alternative is a job guarantee, where the government guarantees work at a living wage.
Temporary measures can include public works programs such as the Works Progress Administration. Government-funded employment is not widely advocated as a solution to unemployment, except in times of crisis; this is attributed to the public sector jobs’ existence depending directly on the tax receipts from private sector employment.
According to classical economic theory, markets reach equilibrium where supply equals demand; everyone who wants to sell at the market price can. Those who do not want to sell at this price do not; in the labour market this is classical unemployment. Increases in the demand for labour will move the economy along the demand curve, increasing wages and employment.
The demand for labour in an economy is derived from the demand for goods and services. As such, if the demand for goods and services in the economy increases, the demand for labour will increase, increasing employment and wages. Monetary policy and fiscal policy can both be used to increase short-term growth in the economy, increasing the demand for labour and decreasing unemployment.
However, the labour market is not 100% efficient: it does not clear, though it may be more efficient than bureaucracy. Some argue that minimum wages and union activity keep wages from falling, which means too many people want to sell their labour at the going price but cannot.
This assumes perfect competition exists in the labour market, specifically that no single entity is large enough to affect wage levels. Advocates of supply-side policies believe those policies can solve this by making the labour market more flexible. These include removing the minimum wage and reducing the power of unions.
Supply-siders argue the reforms increase long-term growth. This increased supply of goods and services requires more workers, increasing employment. It is argued that supply-side policies, which include cutting taxes on businesses and reducing regulation, create jobs and reduce unemployment. Other supply-side policies include education to make workers more attractive to employers.