Relationship between Unemployment Rate and GDP, Interest Rate and Inflation Rates - Research Paper Example

Customer inserts his name Customer inserts tutors name Unemployment rate 19th September 2014 Abstract Employed population in a country means the population that supplies their labor in economic productivity in a country. They are portion of the population provides their services for country to provide goods and services that forms the basis of Gross Domestic Product of the country. High unemployment rate is likely to constrain the secondary, because of a high employment rate has a counter-productive effect on the GDP. Thus, the conducted study primarily is aimed in assessing the overall impact of economic performance when linked to unemployment rate in USA. More specifically, it investigates the influence of inflation rate, GDP and interest rate in accordance to the unemployment rate. Therefore, this paper is intended to be a humble contribution to the existing foundation of theoretical literature pertaining to unemployment rate. The hypothesis on the relational significance of macroeconomics variable and unemployment rate was tested using econometric models. Background and rationale of the study Recently global economic crisis was generated from America which resulted in severe economic depression which caused many organizations to go bankrupt and millions of people worldwide lost their jobs. Now countries are in line to go bankrupt which has caused unemployment in these countries to reach highest record in history of these countries. The global economic crisis was generated by American banks investing highly in house mortgages and excessive derivative trading. These banks crashed when these mortgages went bad as majority of the people dealing with these mortgages were unable to settle their obligation and hedging market which was being valued over trillion United States Dollars crashed resulting in several financial institutions in America to go bankrupt. One of the few famous organizations that were liquidated was Lehmann Brothers and AIG. These bankrupts caused a global crisis as millions of investors lost their investments causing public to fear investing in companies which significantly reduced the demands of securities. The crisis also demolished the retail estate business in America. When these organizations went out of business this caused millions of employees to lose their jobs. Since recovery has been slow countries are still finding it hard to increase their employment level to pre-crisis situation. After organizations went bankrupt dependence of several countries on United States market also backfired for such countries. Greece and Ireland applied for bail out and now Spain and Italy are next in line to apply for bail out plea. This has worked adversely for these countries as unemployment levels are still high in those countries. People are now leaving Greece for prospects of job elsewhere in developed world. The governments try various methods in order to ensure that unemployment levels remain low enough for state to provide for. The governments introduce unemployment benefits plan which ensure that unemployed individuals are provided for by the state and under these programs people are paid money to facilitate their basic needs. Governments also try to ensure that there are enough barriers for foreigners to ensure that local businesses continue to thrive and grow. This allows local businesses to grow and governments use trade barriers to ensure that foreign products either do not reach the country or dumping by countries such as China is prevented to have its negative impacts on local businesses. Governments also try to complicate the visa process or only demands people from other countries to apply for visa when they meet the requirements of profession which is in demand in the country. Thus it can be concluded that unemployment under economic context is a wide term. There are various social, psychological and political costs associated with unemployment and to combat these negative effects a government may use state provided unemployment benefits to unemployed citizens or it may provide necessary trade and employment barriers to foreigners in order to ensure that people holding a country’s nationality are allowed a fair chance to be employed in their own country. Objectives of the study The research was intended to add to the theoretical literature on unemployment after financial crisis of 2008/2009. Economists have also argued that there will always be some sort of unemployment. There is no possible full employment can be achieved. Basing results on these conditions it has been argued that some people would remain unemployed. This assumption was used by an economist that agreed that full employment was ideal and citizen’s psychology to apply for a better job would keep some individuals from getting employed. This phenomenon is called frictional employment. Hidden unemployment is another theory that economists use to argue that statistics will not be able to incorporate all of the unemployed individuals. Unemployment is undesirable for various reasons but the governments have to make peace with the fact that even under best circumstances there will be unemployment. The main objectives can be summarized as follows: i. To investigate the role of interest rate in affecting unemployment rate ii. To explore the impact of inflation rate on unemployment rate iii. To investigate the impact of GDP on unemployment rate The aim of this paper is to construct an Econometric model to determine the relationship between the variables that influences unemployment in an economy. In the paper, the testing will help to determine or find if the claim that the GDP has got predictive power in determining the unemployment rate. Data is presented in by use of tables. Hypothesis Hypotheses: There’s a relational significance between macroeconomics variable and unemployment rate. To test the above hypothesis, several methodologies are employed. The research is both quantitative and qualitative. The qualitative research method that was used be used through the entire study. Data shall be sourced from reputable government agencies such as the Bureau of Labor Statistics and Census. This should help me enable to establish the theoretical framework of the paper. What is also very important, information gathered from that sources will extend my knowledge about the subject and let me improve my understanding of the topic. Literature review Unemployment does not only result in loss of economic production and budget, but it also causes debilitating consequences on the person who is not prepared for it. Unemployment may come abruptly that it becomes a source of enormous stress. According to the American Psychological Association (APA), 78 percent of Americans reported that money is the source of their stress (Bolger). A considerable body of evidence showed that unemployment has significant adverse effects on several dimensions of well-being. The CESC data compared the circumstances of employed and the unemployed using several indicators of well-being, including happiness, health and life satisfaction. The results indicated negative effects on unemployment on well-being. Based on the data, the unemployed are found to be less happy, have poorer health and less satisfied (Saunders, 26). These consequences are caused largely by the impact of unemployment on the financial status, social status and self-esteem. Emotional Effects Unemployment can have devastating effects on the emotional health of a person, particularly in their self-esteem and self-worth. The emotional health of a person is reinforced by his belief in himself and his capabilities. In relation to this, humans strive to enrich themselves by contributing to their family and community. However, unemployment could take away this belief. Losing the ability to secure something for oneself could lead to anxiety, self-doubt, low self-esteem and feelings of hopelessness (Goldsmith et al., 12). As the feelings of rejection and hopelessness surface, it would be very difficult for the affected person to take these feelings off. Prolong feelings of hopelessness and negative emotions could lead to depression (Grohol, 11). Hence, depression is considered as a very common indicator of the impacts of unemployment on a person (Ayers et al., 27). In addition, some people equate their self-worth with the kind of job they have. Placing that much importance on ones job will inevitably result in frustrations when one losses the job. Apparently, unemployment could be very painful, especially if one remains unemployed for a long time. In fact, the deep emotional impact of unemployment could turn some people suicidal after several months or years of unending job search without getting employed (Grohol, 11). The emotional consequences of unemployment often occur in stages. The emotional meltdown often starts with shock, which occurs immediately when one learns about job loss. However, during this phase, the person is still optimistic. As unemployment continues, the person may turn pessimistic and suffers from emotional distress, and ultimately becomes suicidal. Unemployed people are often observed for poor mental health, which is due primarily to the effects of negative emotions such as anxiety, frustrations, disappointment and depression (Goldsmith et al., 43). Mental Effects Paul and Moser (29) reported that unemployed workers are twice more likely to experience depression, anxiety and psychosomatic symptoms, low subjective well-being and low self-esteem (Bolger). In addition, the 1994 study by Clark and Oswald using the data from the British Household Panel Study found that unemployed people have lower mental well-being than those who are working. Similarly, Headey and Wearing (36) reported their findings that unemployment has greater impact on psychological stress, and that unemployed have more emotional strain compared to the employed (Saunders, 28). Indeed, studies which explored the relationship between unemployment and mental health found a negative association between unemployment and mental health. It should be noted, however, that the adverse consequences on mental health are more likely to be sub-clinical symptoms rather than overt and diagnosable mental condition. The relationship between unemployment and poor mental health is supported by the results of longitudinal studies which found that in most cases, the mental consequences are reduced upon resumption of employment. Generally, depression is considered as a strong indicator of the consequences of unemployment (Ayers et al., 12). A recent study suggested that the negative impacts of unemployment on mental health are related to the duration of unemployment. In this study the researchers examined the effects of unemployment on the mental health of individuals who had no bouts of poor mental health within one year prior to unemployment, and the subjects were grouped into three based on their employment history. Results of the study suggest that poor mental health is associated with long-term unemployment while short-term unemployment does not cause significant impact on mental health. The study also found people who are more educated suffer more pronounced emotional and mental consequences of long-term unemployment (Goldsmith et al., 82). Social Effects Studies also presented ample evidence on the adverse social effects of unemployment. Unemployment has been linked to consequences on life satisfaction, family and community life, suicide and criminal activity. According to the Society for the Psychological Study of Social Issues’ Policy Statement “The Psychological Consequences of Unemployment” the stress of unemployment negatively affects the well-being of the individual and the family. That is, the burden of unemployment does not only affect the unemployed individual, but it could also affect the children and the rest of the family. The family of unemployed individual is affected not only by the loss of income, but also by the associated psychological consequences of job loss. (McLoyd 98) stated that the children could suffer if parents become unemployed stress and depressive symptoms caused by unemployment negatively affect parenting practices such as increased punitive and arbitrary punishment. As a result, children also become distressed and depressive (Bolger). Moreover, Australian studies have found causal association between unemployment and poor life satisfaction and criminal activity. This is consistent with the results of the recent study on the association between life satisfaction and unemployment across twelve European countries where unemployment is found to have significant impact on life satisfaction. The study utilized the data from the first wave of the European Community Household Panel and found that although there is slight variation in the strength of the association across these countries, there is no doubt that unemployment adversely affects life satisfaction (Saunders, 29). Unemployment can also motivate a person to commit crimes. In an early comprehensive review provided by Steven Box, he found that out of 50 articles that studied the relationship between unemployment and crime levels, he found that 32 of these studies showed that higher unemployment is associated with more crime. Essentially, unemployment could be a strong motivator for a person to commit crimes, particularly property crimes (Maguire et al., 83). Conceptual and analytical framework An econometric model represents one of a range of statistical tools. These models are generally defined by the role that the data play in calculating the model’s coefficients through a variety of possible estimation methods. An econometric model becomes particularly useful for defining the relationships between the variables, because in the social sciences the facts do not speak for themselves. More formally, an econometric model is a way of testing whether there is evidence for a specific hypothesis, e.g. whether variable y has a significant influence on variable x. While reviewing the literature, a research gap was observed representing a dearth of research studies dealing with unemployment rate. The main motivation driving the conduct of this research with respect to the said topic is more specifically linked to understanding the unemployment rate and macroeconomics variable. The hypothesis has been formulated as a basis for this research study; it was linked with the research objectives to conclude with answering the research questions. The following hypothesis has been posed concerning the relationship between unemployment rate and macroeconomic variable. Factors for unemployment rate Several factors, relating to the macro-economic conditions, affect unemployment rate. For the purpose of this analysis, I assume only GDP, inflation and interest rates these to have remained constants during the researched period. Empirical Model The relational dependence pertaining to unemployment and unemployment rate measures will be tested using econometric modeling. In light of the above discussion, the primary goal of this research is to investigate and understand the overall influence of the topic at hand in terms of the unemployment and inflation, interest rate and GDP as independent variables. The following expression presents the formula used to calculate this relationship. In this expression, β0 indicates the unemployment rate without the interaction of the variables. β1, β2, and β3 represent the differences between the unemployment rate as they relate to the different independent variables. These variables are indicated by the notations set to represent each of them. The explanations for the notations are provided below. On the other hand, e is the residual error term in the sample regression function. Based on this the following equation represents the empirical model for the analysis: Y (Unemployment) = β0 + β1 interest rate + β2 GDP + β3 inflation rate+ ei ei is the estimated error term GDP- Gross Domestic Product e Standard Error Sources of data Most of the data used in the analysis comes from the US Census bureau website. Specifically, data sources used are: Unemployment rates: the US census bureau website at http://data.bls.gov/timeseries/LNS14000000, along with the 2014 update, provides data on unemployment rates. However, this data is not comprehensive and I had to get additional data from http://www.data360.org/dsg.aspx?Data_Set_Group_Id=248&count=500 Inflation: the data used is the year closing number, i.e. the reported inflation rates for December for each year and extracted from http://www.usinflationcalculator.com/inflation/current-inflation-rates/ GDP: Both sets of data extracted from http://www.multpl.com/us-gdp-growth-rate/table/by-year. Data Analysis and Inference- Results Estimation This section addresses the results based on the data collected. The purpose of the analysis was to find plausible answers to the research questions related to the role and influence of macroeconomic factors in relation to the ability of the economy to reduce employment rate due changes in the variables. The results explained the relation entailing the various variables in a depending and independent capacity while subjected to the control variables developed during the study. The model does not incorporate a noise term based on the assumption that this is zero on average in a good regression fit. The results of the regression analysis are Model Unstandardized Coefficients Standardized Coefficients Collinearity Statistics B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) .085547 0.009293 9.2057 3.37E-06 GDP .11291 .1706 -.272 .66174 .52309 .543 1.842 Inflation rate -.51129 .346125 -.042 -1.4771 .17041 .556 1.799 Interest rate -.73814 .234547 -.126 -3.1471 .01038 .442 2.263 Unemployment rate = 0.085547 - 0.73814 interest rate + 0.11291 GDP - 0.51129 inflation rate Referring at the GDP coefficients, we find that GDP is an important factor in correcting errors that can arise in the process of determining an employment rate. Using this variable the unemployment rate is on average when the value is equal to one. The coefficients on inflation rate indicate that its increase contributes to decrease unemployment rate. The coefficients on interested are an indication that the unemployment rate reduces by 0.7 when increasing. Using the independent variables separately, the null hypothesis that the coefficients are =0 i.e. they have no effect whatsoever on the dependent variable is not borne out by the results as the P-values in the case of GDP AND inflation rate are significantly higher than the threshold value of 5%. This indicates that these factors significantly influence unemployment rate. On the other hand, interest rate have little significance also borne out by the correlation analysis. Looking at all variable it can be concluded that there is no multicollinearity as VIF lies between 1.164 and 4.537 which are d less than 5(Farrar and Glaber, R. 2011). Table 1: Regression Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate Durbin-Watson 1 . 84182(a) .708668 . 621268 8.00680 1.787 a Predictors: (Constant), GDP, Inflation rate, interest rate b Dependent Variable: unemployment rate Another important measure in regression analyses is the coefficient of determination which is R2 which has value of 0.287. It indicates that 28.7% of the variability is explained by the model and it is fixed effects model. The Durbin-Watson test is 1.682 meaning there are differences between the coefficients of variables are non-significant for the model. DWH test was utilized to gauge the importance of the divergence in model parameter coefficients. This connotes that no fixed effect null hypothesis is rejected. This unambiguously points out that the pooled OLS regression model is the most apposite. The R-Square value of 70.87% shows that there exists a good fit between the independent and the dependent variables. The Durbin-Watson test to test the significance of coefficients in Δunemployment rate we find that it is 1.787 thus non-significant. ANOVA   df SS MS F Significance F Regression 3 0.00335 0.001117 8.108367 0.004942 Residual 10 0.001377 0.000138 Total 13 0.004728       The result of the traditional F-Test is a significantly low 8.108367 helps reject the null hypothesis that the selected independent variables has power to explain the variations in the dependent variables. Deploying the f-test (p-value) delivers a similar result, in that because of the significant difference (5% > 0.004942%) between the 5% hypothesis and the probable f-statistic the model has significant power to explain the changes in unemployment rates. Discussion Unemployment is a consequence of the changes in the economy and therefore it depends on the economic condition. Recessional periods are especially responsible for the loss of jobs of many people. Sadly, unemployment causes people’s suffering not only due to the loss of financial resource. Unemployment is known to affect the emotional, mental and social well-being of the unemployed person. People who are unemployed are found to have lower psychological well-being, and thus, they can be overwhelmed by negative emotions. Interestingly, not only those with low education and unskilled workforce are affected by unemployment. In fact, it was found that the more educated the unemployed person is, the greater will be the effects on his well-being. Apparently, it is difficult to maintain a healthy economy. However, knowing the cost of joblessness to a person, it is important to reduce unemployment. The interest rate brings a noticeable increase in the unemployment rate. It is important to take caution in some cases when interpreting these results. In the economic theory, these factors are related because they are in one way or the other interrelated. The interest rates are a determining factor for money that is circulating in the economy. If the interest rates are high, a few people will borrow loans from financial institutions and this will affect the amount of money that is transacted between financial institutions. This result is depicted in the balance of payments of any country and shows the level of transaction between a country and its trading partners. The BOP in such a case will be calculated as a negative in the financial structure because there will be more money going out of the economy rather than into the financial system. The gross domestic product is always measured by the category and quantity of labor that is put into an economy and for this reason when there is unemployment is in the economy, there is bound to be low work force that results to lower GDP. Employment in any country’s economy results to economic growth that is summated by the GDP. However, unemployment leads to little financial enlargement that leads to a lower GDP than it would have been realized if the entire work force was working. Economic growth is historically also determined by the inflation rates. If the inflation rates are high, the economic growth tends to be low or stagnant due to low productivity. Real economic growth for the year 2000 stood at 5% from the previous year; however the growth rates reduced to 3% in the subsequent three years. This is a ¼ of the rate of inflation in the period of fourteen years. Money supply growth in the economy is not directly related to joblessness. However, the two variables are one way or another related. Money supply growth in the economy results to a decrease in the number of job opportunities due to inflation. In return, the employment sector fires more people; this is return increases the levels of unemployment in a country drastically. The money supply historically has always had a negative effect on the rates of unemployment. Conclusion This research attempted an analysis of the trend in unemployment rate over the period 2000-2013. The aim was to understand whether a relationship exists between unemployment rate and factors such as GDP, interest rate and inflation rates. The findings show that while GDP growth rate and inflation rate influence unemployment rates, interest rate have no effect. Overall, the empirical model developed from a brief review of earlier literature helps explain trends in unemployment rates. This analysis has thrown up several areas that require further research because the findings appear contrary to one would expect intuitionally. For example, higher interest rates ought to lead to financial difficulties among businesses and affect their ability to maintain jobs. Works cited Ayers, Susan, Andrew Baum, Chris McManus, Stanton Newman, Kenneth Wallston, John Weinman and Robert West . (2007). Cambridge Handbook of Psychology, Health and Medicine, 2nd edn. Cambridge University Press, http://assets.cambridge.org/97805218/79972/frontmatter/9780521879972_frontmatter.pdf Bolger, Kevin. Psychological Effects of Unemployment and Underemployment. 2012, from . Goldsmith, Arthur. and Timothy Diette, (2012). Exploring the link between unemployment and mental health outcomes. Retrieved on August 29, 2012, from < http://www.apa.org/pi/ses/resources/indicator/2012/04/unemployment.aspx > Grohol, John (2011). The Long Unemployed: Emotional Effects of Unemployment. Psych Central. Retrieved on August 28, 2012, from http://psychcentral.com/blog/archives/2011/09/19/the-long-unemployed-emotional-effects-of-unemployment/. Maguire, M, Morgan, R and Reiner, R (2007). The Oxford Handbook of Criminology, 4th edn. Oxford University Press. Saunders, Peter (2002). The Ends and Means of Welfare: Coping with Economic and Social Change in Australia. Cambridge University Press, 2002. Print Us inflation calculator, 2014 Historical Inflation Rates: 1914-2014 http://www.usinflationcalculator.com/inflation/historical-inflation-rates/ US GDP Growth Rate by Year U.S. Bureau of Labor Statistics, 2014. Unemployment Rate http://data.bls.gov/timeseries/LNU04000000?years_option=all_years&periods_option=specific_periods&periods=Annual+Data US Department of Treasury. Daily Treasury Real Yield Curve Rates http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx? data=realyield Read More