Unemployment in Classical Economy - Essay Example

Academia- Research d 20th Nov. 09 Unemployment Introduction Unemployment is of different types and their causes are also of different types. Insufficient effective demand for goods and services in an economy is the main cause of cyclical unemployment according to Keynesian economics. Advocates of Structural economics argue that unemployment is the result of structural problems in economy such as inefficiencies, inherent in the labor market. Classical economics or neoclassical economics focus on rigidities in the labor market caused by the operating laws such as minimum wage act, taxes, and other regulations that restrict employers to hire more workers in the job. There are many who accept unemployed status voluntarily because of unsatisfactory employment available. Disruptive technologies and globalizations also cause unemployment because many workers don't fit in the new jobs that are new technology oriented in which old workers are not trained. Globalization makes the jobs outsourced from other countries making the domestic workers redundant. In downturn phase of an economy wages are generally high because of sticky demand of workers for higher wages and unions disruptive attitude of workers. Advocates of Monetary economics focus on money supply excessive expansion that is responsible for inflationary situation in the economy as the main cause of unemployment. In laissez fair economy every seller gets a buyer at some price called the clearing price. Sellers and buyers may refuse the clearing price voluntarily. But in regulated market the scenario is different.. General Theory claims that the concept of say's law is not practical. Unemployment that is involuntary does not exist. Unemployed person must meet their needs for survival and government of the country supports them to find employment through various schemes. According to classical economics demand for and supply of labor determine the price and employment level is set by these forces. Demand being more will push the wages and employment up and vice versa. Both monetary and fiscal policies can be used to increase short term growth of economy and the following employment level. Supply side is often affected by labor unions. Flexible policies, government attitude, reforms, education make labors supply more flexible that in turn increase supply of goods and increase employment level. Either all these explanations and theories may fit in to answer the unemployment variance in G5 countries or only some of them may be the relevant answer. Unemployment level in G5 countries during 1998-2008 has been different. In USA, Europe and Japan the unemployment levels were at half the rate than in France and Germany. There are three European economies, one American and one Asian in G5. Unemployment trend in USA had been falling from nearly 5% in average in 1992 to marginally above 4% in 2007. For January 2008 in the U.S. the unemployment rates were 4.4% for adult men, and4.2% for adult women.. In Japan the rate has come down from 2003 at 4% to 2% in 2007. In Germany the unemployment rate has been falling since 1993 from nearly 10% to about 4% in 2007. In France the unemployment rate has remained high and fell marginally in2007 only to be above 7%. Traditionally USA experiences lower unemployment levels than countries in Europe. UK and Denmark outperforming Italy and France and it also changes over time throughout economic cycles In Germany unemployment level peaked in 2005 at 10.6 and then fell down up to 7.4 in 2008. The rate of fall is quite sizable from 7.38% to 14.83%. As per Philips Curve employment and inflation are interrelated. Demand stimulus through expansionary policy could increase employment without leading to higher inflation. Here in this case unemployment rate went increasing and inflation rate also remained low. Thus the Philips Curve mechanism does not fit in case of German unemployment development. "Phillips curve suggests that there is a menu of combinations of employment levels and inflation rates the central bank can choose from. In the traditional Keynesian models a demand stimulus through expansionary policy would increase employment without leading to higher inflation because nominal wages and prices were treated as exogenous. With the Phillips curve mechanism providing a link between real and nominal variables, the demand stimulus would still lead to a higher employment level but also to higher inflation. Thus, the Phillips curve suggests that policy makers have to make a trade-off between the unemployment rate and the inflation rate and macroeconomic policy needs to strike the right balance between sustaining robust economic activity and controlling inflation" kap1096.pdf Unemployment levels in Germany and France were the highest during 1998 and 2008 compared to that in USA, UK and Japan. The reason appears to be booming housing markets in US and UK that absorbed huge capital to keep the industry going up and absorbing workers in these countries. The appetite for homes was far bigger in these countries compared to Germany and France. The housing boom started in USA in the year 2000. After the dot-com bubble burst in this year the only safest way to put excessive liquidity was in the real estate in the low interest scenario. Greenspan moved excess liquidity into the $20 trillion house-market. The economic boom bolstered by a decade -long housing boom in UK created consumer confidence and perception of wealth that is not seen in Germany at all. People in Germany are reluctant to borrow more from banks for any damn purchase as Britons do. German markets remained highly regulated that did not allow borrowing like the UK people did for homes. Japan already faced the housing boom and bust in the 80s and still the house prices are falling. In Germany the house prices have been declining without interruption. French market also faced similar static situation. Surprisingly the household debt -to - income ratio in Britain is 1.62-compared to1.09 in Germany. This is bigger than even that of USA, which is 1.42 only. This shows the effective demand in Britain was the highest. Since 2001 banks' credits in US have gone up 83% to$14.9 trillion and the total mortgage debt is up106% over the last six and a half years till 2008. The real estate prices in Germany and in the rest of Europe except UK didn't move much because the market was very much regulated. In other words, it looks like the biggest bubble in history..According to Lombard Street Research, household debt is 165% of disposable income in the UK but only 130% in the US. With UK interest rates 20%-25% higher than in the US, UK borrowers are at least 50% more vulnerable. 70% of bank funds were diverted to real estate mortgage.. I strongly stand by Keynesian economics that insufficient effective demand for goods and services in an economy is the main cause of unemployment. The housing boom in both UK and USA kept the effective demand in these economies high and burning that kept unemployment at lower levels. This effective demand was missing in Germany and France and consequently unemployment rates were higher there. Japan had already witness higher growth and output in 1980 and 1990s partially. Here the unemployment was gradually on the spiral though at lower level compared to US and UK. References Germany Unemployment rate - Economy indexmundi.com/germany/unemployment_rate.html - .Economic growth Statistics by Bank Of England www.statistics.gov.uk/ www.economicsnetwork.ac.uk/archive/household_spending.doc - Property Crash Housing-Market / UK Housing May 01, 2007 - 01:42 PM www.Kap1096.pdf HYSTERESIS AND "THE JAPANESE UNEMPLOYMENT PROBLEM": A PRELIMINARY ... oep.oxfordjournals.org/cgi/reprint/42/3/483.pdfck=nck In recent years of 2007 housing prices in certain countries such as USA, UK, Ireland, Spain were so steeply high that people started anticipating the danger of emerging speculative bubble. US was the real cause for the fear since the country was already in danger on account of sub-prime mortgage that led to property price plunging. UK was likely to be the next economy to go on the path treaded by USA. In UK the house price moved up 300 % never seen before. . Japan already faced the housing boom and bust in the 80s and still the house prices are falling. In Germany and Canada the house prices have been declining without interruption. The housing boom started in USA in the year 2000. After the dot-com bubble burst in this year the only safest way to put excessive liquidity was in the real estate in the low interest scenario. Greenspan moved excess liquidity into the $20 trillion house-market. Lenders were also looking for borrowers even with lesser creditworthiness but new house buyers. Interest rate was already slashed from 5% to 0.75% in 11 installments. They were ready with exotic offers such as 'interest only' loans or 'option adjustable rate' mortgage (option ARMs). These loans were attractive because of low down payment but later the payment was to skyrocket. Banks wrote in average1% of option ARMs all mortgages in 2003 that went up to 15% by 2006. In certain American communities the option was one in every three mortgages written. By 2006 brokers were accountable for 80% of all mortgages originated. Brokers advocated hard for the option ARMs because that was highly profitable for banks and high commission fetching for the brokers. Banks had another advantage to bundle up many mortgages to sell them to investment funds; hedge funds, which used these as collateral for highly leveraged loans. The mortgages bundles were highly unregulated and not properly verified for credit worthiness. Investors who were holding these mortgage- backed bonds were at risk of losing high as a result of home loans given to people with poor credit profile. Since 2001 banks' credits have gone up 83% to$14.9 trillion and the total mortgage debt is up106% over the last six and a half years. There were millions of sub-prime mortgages in USA with reports of about two million of them expected to lose homes to foreclosure according to Pittman 2007. The basic difference between the Britain Consumer debts with Germans o . UK bears a record debt of 1.4 trillion that is more than their GDP. The economic boom bolstered by a decade -long housing boom in UK created consumer confidence and perception of wealth that is not seen in Germany at all. People in Germany are reluctant to borrow more from banks for any damn purchase as Britons do. State-owned banks also don't push for bank loans to earn profits. In Britain the basic mantra is to spend now and think later as American do. The credit environment is easy to promote credit card and loans than to promote saving cards. That is why there are about in average 2.8 credits cards with every youth of Britain more than any German or European has. As a result a common Briton spends quite more than an average German on any common things such as pay for vacation or buying furniture or on medical bills. Surprisingly the household debt -to - income ratio in Britain is 1.62-compared to1.09 in Germany. This is bigger than even that of USA, which is 1.42 only The financial regulators in Britain are almost supportive and control from surface only but in Germany they are very restrictive. This led to proliferation of this market to more sophisticated and large. The real estate soaring prices in Great Britain fuelled the soaring demand for debts. The lower interest rates in early 2000s supported it. The real estate prices in Germany and in the rest of Europe didn't move much because the market was very much regulated. UK is one of the few major developed countries that faced the sub-prime crisis. The crisis took bigger proportion than that in USA with 300% inflation. There is big appetite in UK for housing because of unfulfilled demand from the new settlers and the population growth. . Banks and financial institutions with their excessive liquidity took advantage of this appetite and started providing easy sub-prime mortgages to customers without considering their income standing and by ignoring other requisite principles of lending. . The macroeconomic factors such as higher interest rates, high disposable. If the sub-prime credit lending is available to a large number of risky borrowers this easy access will be available in may multiples to overvalue the property and create bubbles Economic factor such as disposable income and consumption in UK. Credit growth and availability in UK, interest rate ruling in UK and charged by bankers, stock market position, In other words, it looks like the biggest bubble in history. More than 25% of homes bought in USA and UK are for investment purpose not for owner occupation showing that the investment in housing is for speculative motive. Majority of first time buyers did not make any downpayment for the loan sanctioned. The home prices in most of countries have gone up 100% of their GDP to lure specultors in this segment. This is more than the global stock market price rise in 1990s that was 80% of their GDP. The economist There was exponential growth of savings and debt in UK market. They were used mainly for financing the purchase of real estate, stocks and bonds. (Economic growth Statistics by Bank Of England) The ratio of home price to rents received is the indicator of overvaluation of residential real estate.House prices in relation to rent have hit all-time highs in the U.S., Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. Inflation being lower, the real price was comparatively higher showing larger overvaluation of the properties. If prices of the property drops rents will not cover the interest rate paid on mortgages and the investors would like to sell it off. This will increase supply of homes for sell and lead to depression in the market. The UK house market is set to go this way gradually. (The Economist) Lombard Street Research, household debt is 165% of disposable income in the UK but only 130% in the US. With UK interest rates 20%-25% higher than in the US, UK borrowers are at least 50% more vulnerable. 70% of bank funds were diverted to real estate mortgage.. The UK interest rate ruling at the end of 2007 was 5.75% that has been reduced to 5.25% down recently. Interest rate in UK is down from 5.75 to 5.25% to 5% today but inflation is rising from 2% to 2.6%. In 2008 March the UK price inflation fell to 1.4% that is two-year low The UK ARM reset will further aggravate the mortgage scenario The interest rate is comparatively very high if compared with Euro zone rates of 3.75% and US rate of 2.2%. 1998 9.05 -3.47 % 1999 8.267 -8.65 % 2000 7.525 -8.98 % 2001 7.617 1.22 % 2002 8.358 9.73 % 2003 9.308 11.37 % 2004 9.775 5.02 % 2005 10.617 8.61 % 2006 9.833 -7.38 % 2007 8.375 -14.83 % 2008 7.404 -11.59 % In Europe Germany is the largest economy and the most populous country. The real reason of increase in employment in Germany is lower growth in output. The GDP of Germany grew at a rate that was below1%. Inflation rate was 2.0% in 2001, 1.4% in 2002 and 0.7% in May 2003. Fiscal policy was restrictive in 2003. It aimed at reducing the budget deficit. This policy is expected to continue in the next few years as well. Germany had a trade surplus of 119.2 billion euro in 2003 compared to 124.4 billion in 2002 Chapter Summary India has managed an average economic growth rate of 6% since the 1990s. In the period 2000-2003, it averaged 5.8%. In the 1990s, the major contributors to Indian GDP have been traditional farming, modern agriculture, handicrafts, a wide range of modern industries, and support services. India has a history of high inflation rates. However, in recent years it has been well under control. The RBI has been promoting liquidity in the economy since 1996. It took measures such as reducing the CRR, cutting short-term lending rates, and allowing banks to lend loans in foreign currency. The growing fiscal deficit is a macroeconomic problem the Indian economy faces. India's trade has been booming in recent years with increasing IT exports. Brazil is the largest and the most populous country in South America. It is the 10th largest economy in the world. Brazil's economy is expected to recover in 2004 after going through a bad phase in 2003. Brazil experienced high inflation in 2002 and 2003. According to the central bank of Brazil, the fiscal deficit of the regional governments and state owned enterprises grew by 1.1 % of GDP during 2003. The currency of Brazil, the real has been stable in the second half of 2003. The government does not want the currency's value to appreciate in the future as it fears that this might hurt its exports. Economic growth in China in 2004 is expected to be around 7.7 %. Despite the high level of money circulating in the economy, the People's Bank of China (PBOC), the Chinese central bank, does not favor an increase in interest rates. Government spending has been quite high in years 2002 and 2003. The current account surplus of China decreased from 2.9% of GDP in 2002 to 1.8% in the first half of 2003. The US economy is the largest and most developed economy in the world. The economy grew at 3.3% in the second quarter of 2003. The economy posted strong growth of 8.2% in the third quarter. The inflation rate is expected to fall in 2004 due to lower food and energy prices. It is expected that the US Federal Bank will continue its low interest rate policy at least until the middle of 2004. The US fiscal deficit is mounting. The deficit as on March 2004 was US $ 129 billion. The dollar has lost its value by as much as 21% since early 2002 period. US exports are picking up. But trade is not a significant contributor to growth in the US economy at present. Germany is the largest economy and the most populous country in Europe. The GDP of Germany grew by 0.4% in the first quarter of 2003. It fell by 0.7% in the second quarter. Inflation has been low in recent years. It was 2.0% in 2001, 1.4% in 2002 and 0.7% in May 2003. Germany had an unemployment rate of 10.7% in April 2003. This is a marginal increase over the last two years (10.1% in 2002 and 9.6% in 2001). Fiscal policy was restrictive in 2003. It aimed at reducing the budget deficit. This policy is expected to continue in the next few years as well. Germany had a trade surplus of 119.2 billion euro in 2003 compared to 124.4 billion in 2002. 2003 204 05 06 07 /base lone World Output Growth 2.7 4.0 3.5 3.9 3.8 1.8 2.1 2.8 2.9 0.8 1.4 Developed economies 1.9 3.0 2.4 2.8 2.5 0.6 0.9 1.4 1.6 -0.3 0.7 United States 2.5 3.6 3.1 2.9 2.2 -0.2 0.2 1.0 1.2 -1.3 0.3 Euro zone 0.8 2.0 1.5 2.8 2.6 1.1 1.2 1.7 1.7 0.4 0.9 Japan 1.4 2.7 1.9 2.2 2.1 0.9 1.2 1.3 1.5 0.3 0.9 Country-specific Note: Definition: Unemployment rate, harmonized definition ILO (International Labour Organization). . Source: National Statistical Office Latest actual data: 2008 Notes: Data until 1990 refers to German federation only (West Germany). Data from 1991 refer to United Germany. Primary domestic currency: Euros Data last updated: 09/2009 Source: International Monetary Fund - 2009 World Economic Outlook Year Unemployment rate Percent Change 1980 3.359 1981 4.831 43.82 % 1982 6.734 39.39 % 1983 8.099 20.27 % 1984 8.058 -0.51 % 1985 8.124 0.82 % 1986 7.834 -3.57 % 1987 7.843 0.11 % 1988 7.735 -1.38 % 1989 6.79 -12.22 % 1990 6.155 -9.35 % 1991 5.47 -11.13 % 1992 6.342 15.94 % 1993 7.617 20.10 % 1994 8.208 7.76 % 1995 8 -2.53 % 1996 8.667 8.34 % 1997 9.375 8.17 % 1998 9.05 -3.47 % 1999 8.267 -8.65 % 2000 7.525 -8.98 % 2001 7.617 1.22 % 2002 8.358 9.73 % 2003 9.308 11.37 % 2004 9.775 5.02 % 2005 10.617 8.61 % 2006 9.833 -7.38 % 2007 8.375 -14.83 % 2008 7.404 -11.59 % 2009 8.015 8.25 % Germany Unemployment rate - Economy ... actual data: 2008 Notes: Data until 1990 refers to German federation only (West Germany) ... 1998. 9.05 -3.47 % 1999. 8.267 -8.65 % 2000. 7.525 -8.98 ... indexmundi.com/germany/unemployment_rate.html - The Phillips curve establishes the link between monetary policy and inflation.Monetary policy can affect the level of aggregate employment in the economy through its influence on aggregate demand conditions. This implies that monetary policy can exercise control over inflation via the Phillips curvemechanism. Moreover, the Phillips curve suggests that there is a menu of combinations of employment levels and inflation rates the central bank can choose from. In the traditional Keynesian models a demand stimulus through expansionary policy would increase employment without leading to higher inflation because nominal wages and prices were treated as exogenous.11 With the Phillips curve mechanism providing a link between real and nominal variables, the demand stimulus would still lead to a higher employment level but also to higher inflation. Thus, the Phillips curve suggests that policy makers have to make a trade-off between the unemployment rate and the inflation rate and macroeconomic policy needs to strike the right balance between sustaining robust economic activity and controlling inflation. The assumption of a stable Phillips curve, which corresponded well to the experience in the United States in the 1950s and 1960s, implies that fiscal and monetary policy are powerful both in the short-run and in the long-run.13 In particular, this implies that money is not super-neutral in the long-run:14 If monetary policy increases the rate of growth of the money supply, prices are always one step ahead of nominal wages, because the latter are assumed to adjust only slowly to the rising price level. As a consequence the real wage declines permanently, the employment level increases and unemployment declines.15 Thus, an Increase in the rate of growth of money has long-run effects on real variables. Source: International Monetary Fund - 2009 World Economic Outlook Read More