[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Wrap-Up
FORMS OF UNEMPLOYMENT
Seasonal
Frictional
Structural
Cyclical
OUTPUT GAPS AND THE NATURAL RATE OF
UNEMPLOYMENT
Earlier, we defined the output gap as the percentage gap between GDP and potential
GDP. When the output gap is zero, real GDP is equal to potential GDP and the
economy is at full employment. Full employment means not that the total unemployment
rate will be zero—there will still be seasonal, frictional, and structural unemployment—but
that there is no cyclical unemployment. The unemployment rate
that occurs when the output gap is equal to zero is the natural rate of unemployment.
When the output gap is equal to zero, the actual unemployment rate equals
the natural rate of unemployment. When the output gap is positive, the actual unemployment
rate will be below the natural rate of unemployment; when the output gap
is negative, it exceeds the natural rate of unemployment.
The natural rate of unemployment can change over time because of such
factors as changes in the age composition of the labor force. For example, young
workers typically experience higher unemployment rates than do older workers;
thus, when the baby boom generation first began entering the labor force in the
1960s, the unemployment rate associated with a zero output gap rose. In the
1970s and 1980s, most economists thought the natural rate of unemployment was
around 6 percent. Because workers in their forties and fifties tend to experience
lower unemployment rates, the natural rate of unemployment fell as the baby
boomers aged. Today, many economists put the natural rate at around 5 to
5.5 percent.
The connection between fluctuations in the unemployment rate and fluctuations
in the economy’s production is illustrated in Figure 22.4. The horizontal axis plots the
output gap. On the vertical axis is the unemployment rate. The downwardsloping
relationship between the output gap and the unemployment rate stands out
clearly. Arthur Okun, who served as chairman of the Council of Economic Advisors
under President Lyndon Johnson, showed that as the economy pulls out of a recession,
output increases by a greater percentage than the rise in employment. And as
the economy goes into a recession, output decreases by a greater percentage than
the reduction in employment. This result is called Okun’s Law. Current estimates
of the relationship between the output gap and employment predict that a 1 percent
increase in the unemployment rate will correspond to about a 2 percentage point
reduction in the output gap.
UNEMPLOYMENT ∂ 503