How does a good economy affect unemployment?

A viewer asked this question on 7/12/2000:

How does the state of the United States economy affect the rate of unemployment and population?

JesseGordon gave this response on 7/13/2000:

Well, as usual, there's a difference between theory and practice.

The basic theory of macroeconomics (which is what affects large scale things like the US economy) says that unemployment and inflation are opposites. If unemployment goes too low, inflation goes up, because low unemployment drives wages upwards, and all prices follow. Under that theory, the goal is to get the lowest unemployment possible which doesn't create higher inflation.

The question then is, What's the point at which unemployment goes too low? Economists have an acronym for that point, "NAIRU", which means the "non-accelerating inflation rate of unemployment." Until a few years ago, the NAIRU point was considered to be about 5% unemployment -- if you went below that, you'd get inflation.

Now comes the difference in practice. Our current unemployment rate is barely above 4%, and the inflation rate is under 2%. That's not supposed to happen -- inflation should be rising. There are lots of theories about why, usually focusing on the new high-tech economy.

On the specifics of your question, the state of the US economy is usually measured as how much inflation and how much unemployment we have. Those two used to be combined into the "misery index", which we don't hear about much any more because it's pretty low.

In any case, your question is reversed -- unemployment DEFINES the state of the US economy, not the other way around. Having jobs is what people care about, and hence is what economists measure and what politicians work towards achieving. So of course, when the economy is good, unemployment is low -- if unemployment ISN'T low, the economy won't be called "good."

There are other measures, of course, such as GDP growth, inflation, and others. If GDP growth is high, unemployment should be getting lower (since more GDP implies more jobs to produce more goods & services). The Fed currently focuses on regulating GDP growth by "cooling the economy" via higher interest rates when GDP grows too fast, to avoid inflation via too-low unemployment. You can read about that at .

With regards to population, I think you're getting at the old pre-industrial idea that a good economy causes population growth. That's not really true in an industrialized society. It used to be true, when a lot of kids died young and people needed kids to work the farms and take of them in their old age. Once we reached a situation where few children die, and there's a social safety net for our old age, the number of kids you have is no longer much dependent on the economy. Ask a follow up about demographics if you want more on this.

Calli5to627 rated this answer:

The answer helped me a lot. Thanks so much

Anonymous asked this question on 6/22/2000:

Laszlo, what are your thoughts on the following statements?

1. "In the long run, macro policies can do little to change the average rate of unemployment."

2. "Increasing unemployment compensation payments reduces the incentive of unemployment workers to take available jobs. High unemployment benefits are a source of high rates of unemployment."

budgetanalyst gave this response on 6/23/2000:

Your questions have more to do with economics than U.S. government, so you may want to also try them at the economics section. But I will give them a try:

1. This one is debatable since any activity on the part of the government has an effect on the economy. It all depends on what is being done. Running large deficits (which is a Keynesian prescription for increasing employment) will not do so in the long run - after all, Keynes is the one who stated that "in the long run we are all dead." On the other hand, controlling government spending and reducing the demands that the government places on money markets can free up resources for economic growth, which then leads to increased employment. We are currently in this situation in the U.S.A. - the government is running surpluses, reducing its debt, and reducing its borrowing needs.

2. Yes. If people get more for doing less (i.e., money for not working), they will do the logical thing and take the more for less. This is the problem in many countries in Europe, where the unemployed are in many ways better off than those making minimum wage in the U.S.A. Unemployment compensation should be set at a level that makes it more attractive to seek employment than to stay at home. (This was the argument used to change the welfare system a few years ago - it was argued that recipients would rather take the dole than work because the tradeoff was not rational - they were better off not working as long as the got welfare benefits; similar arguments can be made of unemployment insurance.) (PS: I do not want to address the equity and justice issues related to changing the welfare system; there are problems. I am simply using it as a way to illustrate the point.)

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