Chapter 10: Inflation & UnemploymentVictoria Wong, Kevin Chan, Kelvin Leung, Rachel Lam

2008-2009 Edition

Strategies to Achieve Price Stability and Employment

Solutions for inflation 1. The monetary policy protects the value of Canadian dollar by

keeping inflation low and stable creates a positive climate for low interest

rates and long term investments, which will strengthen the economy and generate new jobs

Inflation-control target Set the current range within 1 to 3% to prevent significant deflation Act as a growth stabilizer to avoid recurrence of the inflationary “boom-and-bust” cycles in the early 1980s and 1990s If inflation is moving towards 1 to 3 % target range, sign that demand in economy for goods and services needs to be restrained through a rise in interest rates If inflation is moving towards the bottom of the range, demand for goods and services is low and needs some support by reducing interest rates

Target for the Overnight Rate Tool to send signal about the

direction in of short-term interest rates to go

Bank may raise interest rates to slow down borrowing and spending, putting a brake on inflation

Choosing a Target for the Overnight Rate, the Bank of Canada picks a level that it feels will keep future inflation low, stable and predictable

Solutions for Unemployment

Create a National office of Employment – to develop long term strategies by oversight the Canadian labour market in order to track trends, analyze data, research problem, and prepare intervention

Identify growing and potential industries Update training courses for people to learn current

skills for new jobs Offer tax incentives for business to hire Develop reward programs to employers with tax

credits for hiring long-term employed and new trainees

Implement coordinated support programs that workers participate as part of receiving unemployment benefits and employers participate as a means of meeting their future needs for staff

Encourage employers to hire more part-time workers and companies to promote a new work ethic for workers, such as reduce work hours, increase leisure and volunteer activities etc., to allow more workers to be employed.

Discussion Questions

1. Referring to the article, “Aging society a threat and an opportunity”, what are some ways baby boomers can contribute after they retire?

2. In your opinion, do you believe that the government is falling behind in dealing with this situation? If so, what do you think can be done? If no, why? What policies are best to deal with the current economic crisis?

3. Based on the article, what implication does this have on the economy?

10.1 Inflation Inflation a(n) increase in the general level of

prices Deflation a(n) decrease in the general level

of prices The Consumer Price Index The consumer price index (CPI) is the most

common measure of inflation. A “ shopping basket ” of consumer products

is used to monitor price changes.

Simple ConsumerPrice Index

Ex. 1

Prices QuantityConsumedper Month

Expenditureper Month

Weights

$20

$30

$50

$20 ÷ $50 = 0.4$40 ÷ $50 = 0.6

1030

$2.00

$1.00

Hamburgers

Milkshakes

Results of 2000 Survey

Prices 2001 Price 2000 Quantity

$2.20 x 10 = $22.00

$1.05 x 30 = $31.50

$53.50

$2.20

$1.05

Hamburgers

Milkshakes

Prices in 2001

Simple Consumer Price Index Cont.

This sample survey allows you to compare prices in the current year those in the base year.

Ex.2. This shows the items weights for the major components of the CPI. Among a variety of Canadian communities, every month the prices of about 600 representative products are added to the CPI shopping basket to be calculated. Typically, rising prices, results to the percentage increase in the CPI represent the inflation rate.

Consumer Price Index Weights (1992) Page 238

Food 18.0%

Shelter 27.9%Household operationsand furnishings 10.0%

Clothing and footwear (6.6%)

Transportation 18.3%

Health and personal care 4.3%

Recreation, education,and reading 10.4% Alcoholic beverages and

tobacco products 4.5%

Nominal versus Real Income

The CPI can help consumers determine cost of living, or the amount they must spend on the entire range of goods and services they buy. A way to determine how a consumer’s purchasing power is affected by inflation; we can express one’s nominal income as a real income. The following formula can be used to determine real income for a given year.

Real Income= Nominal income CPI (in hundredths)

Nominal versus Real Income Cont.

The purchasing power of a current dollar is inversely related to the CPI: the lower the CPI, the higher is the purchasing power of the nominal income, and vice versa. A higher standard of living will result by those whose incomes increase at a higher rate than the rise in prices.

Limitations of CPI

The CPI does not consider consumer differences, changes in spending patterns, and product quality. Consumer consumptions are only based on an average household. Using the CPI it can lead to a bias in the stated inflation rate.

The GDP Deflator

It is an indicator of price changes for all goods and services produced in the economy and weighs them in terms of the economy’s total output.

It includes quantities that change each year. It compares prices in the current year with those in a base year. The values for this index are not quickly available as values for the CPI. GDP deflator receives less publicity than the CPI.

GDP Deflator = Nominal GDP x 100 Real GDP

The GDP Deflator Ex.

(1)Year

(2)Output ofMicrochips

(3)Current

Price

(4)Output at

Current Price(2) X (3)

$0.200.300.40

$200600

1000

100020002500

200020012002

(5)Output at2000 Price(2) X $0.20

$200400500

(6)GDP

Deflator[(4) ÷ (5)] x 100

100150200

Nominal versus Real GDP

Nominal GDP is expressed in current dollars, where as real GDP is expressed in base-year dollars. The real GDP can be determined by the following formula:

Real GDP = Nominal GDPGDP deflator

Nominal versus Real GDP Ex.

.

(1)Year

(2)Nominal GDP

(current $ billions)

(3)GDP Deflator(1992 = 100)

23.47100.0

0112.7

3

$76.3698.5

1038.8

196819922000

(4)Real GDP

(1992 $ billions)[(2) ÷ (3)] x 100

$325.1698.5921.5

Inflation redistributes purchasing power between incomes, and borrowing and lending

Many labour unions negotiate adjustments such as the cost-of-living

Three types of indexation include: fully indexed incomes, partially indexed incomes, and fixed incomes

During periods of inflation, people who are fully indexed to inflation rates maintain their purchasing power, while those with partially indexed or fixed incomes lose purchasing power

Actual inflation > anticipated inflation; Borrowers gain Actual inflation < anticipated inflation; Lenders win Actual inflation = anticipated inflation; Lenders and

borrowers are unaffected

Inflation’s Effects

Inflation’s Effects

Real interest rate = nominal interest rate – inflation rate

Nominal interest rate = desired real interest rate + inflation premium

10.2 Unemployment

The Labour Force Survey Statistics Canada keeps track of the

Canadian workforce through a monthly survey. This survey measures the labour force population, which is a random sample taken form Statistics Canada for the labour force survey with specific exclusion.

Labour force refers to people who either have a job or are actively seeking employment

Participation rate = Labour Force x 100Labour force population

The Official Unemployment Rate

Unemployment rate= Unemployed in labour force x 100 Labour Force

Drawbacks of the Unofficial Unemployment Rate

The factors affecting the official rates are:

Underemployment Discouraged workers Dishonesty

Types of Unemployment

Frictional Unemployment

Structural Unemployment Cyclical Unemployment

Seasonal Unemployment

Guess my type of Unemployment

Frictional Unemployment I am a student who has just graduated

from university seeking for career-related jobStructural Unemployment

I am a manufacturing worker and I lost my job because of automation in the firm, yet he does not have skills for working in the service sector. Hence he’s unemployed.

Guess my type of Unemployment

Cyclical Unemployment I am an auto worker and I often

work overtime when there is a lot of business demand for cars but be laid off times when there is less work

Seasonal Unemployment I work as a lifeguard at the beach

in the summer but I am unemployed in the winter

Full Employment

The highest reasonable expectation of employment for the economy as a whole

It is defined in term of natural unemployment rate

Includes frictional and at least some structural unemployment

Full Employment

Structural Changethe change from manufacturing sector to service sector

Unemployment insurance Unemployment insurance allows job seekers to devote more time and effort to search for employment, hence it increases frictional unemployment

Change participation rate

young unskilled workers have a higher frictional unemployment than experienced workers

Minimum wages

The Costs of Unemployment The economy losses the output of workers

could have produced. By calculating the potential output, which

is the measurement of the real output, or GDP, associated with full employment, we can get the cost of unemployment for the entire economy. According to Okun’s Law for every percentage point that the unemployment rate exceeds the natural unemployment rate the gap between potential output and real output is 2.5%.

The Costs of Unemployment

Ex.5Given the data as follow:

Total population 15 years of age and over 4.2 million

Those 15 years of age and over not in the labour force population 1.4 million

Part-time workers who wish to have full-time jobs 100 000

Part-time workers who do not wish to have full-time job 300 000

Workers with full-time jobs 1.2 million Unemployed members of the labour force 150 000

The Costs of Unemployment Exercise

Calculate the labour force population the labour force the participation rate the official unemployment

rate the unemployment rate,

include underemployment and discouraged workers

Boom, Bust & Echo

David K. Foot is a well-known Canadian economist and demographer. He suggests that our ages can give us insights about our future. Foot wrote the book Boom, Bust and Echo. It outlines some of the effects of Canada’s huge baby-bust generation (people born from 1947 – 1966), Baby-bust generation (people born from 1967-1979), and baby-boom echo generation (people born from 1980- 1995).

Demography is the study of human populations used to understand the past and to predict the future. The 2 key factors to predict: the number of people in each age group & the probability the each person will participate to a given behaviour.

The Baby Boom (1947 – 1966)

The reason to this was due of the post-war economy which was robust and young people wanted large families. Another reason was the high immigration levels prevailed during the 1950’s.

The front-end boomers had a lot of wonderful opportunities after the vast numbers of young baby-boomers into the marketplace during the 1970s – 1980s.

Things were tough for the late- 1950s group due to horrendous obstacles in the market place, and were unable to get their careers on track. The 3.1 million people born from 1961 to 1966 is referred to the generation X in Douglas Capland’s fictional novel and the term is still widely used today.

While front-end boomers were earning 30% more than their fathers by age 30 and back-enders were making 10% less their fathers.

The Gen-Xers had to cope with their parents. While the 60 year olds were successful, the father sees his son’s failure as a result of lack of drive and ambition.

The Baby Bust (1967-1979)

The commercial introduction of the birth control pill in 1961 and increase of women in the labour market led a decline in fertility over the 1960s.

As a result, this decline in birth rates became known as baby bust.

These baby busters have little to no difficulty in finding part-time jobs in high school, unlike their siblings.

In the 1990s, university entry standards have declined, hence making it easier for these baby busters to get into the school of their choice.

The Baby Echo (1980-1995)

As of 1998, there were 6.5 million members of the echo generation.

Like the baby boom, the echo has a front end born in the 1980s, that will have an easier ride then its back end, born in the first half of the 1990s.

Gen X-II should be better prepared than its parents were to cope with high youth employment and other difficulties associated with a large cohort.