Thursday, January 15, 2009
Suppose that you are a freshman in high school thinking about asking a young lady to the homecoming dance. If you were repeatedly turned down, how long would you continue to find a date? Many would quit looking for a date. This is the analogy that Wayne McCaffery uses when he teaches how the duration of unemployment affects the long-term growth.
According to Mr. McCaffery, "...duration of Unemployment. Median duration of unemployment was 8.3 weeks a year ago, and now it is 10.6 weeks, not good. And of those 7.2% unemployed, 17.3% of them were unemployed for 27 weeks or more one year ago. And now 23.2% of the unemployed have been there for 27 weeks or more. This is a major source of the "marginally attached" to the labor force, the discouraged worker. Try looking for work, applying for jobs for 27 or more weeks. Pretty depressing."
What are the effects on the natural rate of unemployment? As Mr. McCaffery noted, there are human costs that include attrition of job skills. An unemployed worker will also lose the opportunity to acquire new skills. As a result many employers will be reluctant to hire the long term unemployed who give up looking for work and become discouraged. (Discouraged workers are not counted as part of the labor force.) Some of the chronically unemployed may become depressed.
Another effect of long-term unemployment is the increase in the natural rate of unemployment. The chronically unemployed will be unemployable. These discouraged workers will not pose a credible threat to employers by asking for higher wages. In fact, those still employed will exert an upward pressure on wages increasing the natural rate of unemployment. This theory is called Hysteresis and is used to explain why unemployment is higher in Europe than the US.
In periods of disinflation, which is what I expect to happen, the costs are larger. If one defines the real wage as W/P where W is the nominal wage and P is the price, a declining P, price level, will raise real wages and the cost of hiring more workers. Probably, the sub-group most hurt are the young who move from job to job quickly to take advantage of income differentials.
(This blog is dedicated to Wayne McCaffery who always inspires me to reach my potential.)