Cyclical Unemployment: When Recession Happens

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Cyclical unemployment is the primary culprit behind high unemployment rates. As its name implies, this type of unemployment is related to the cyclical trends in the business cycle or the industry. Simply put, if the economy is doing well, the number of people cyclically unemployed is low. But if economic growth starts to falter, cyclical unemployment levels are sure to rise.

Cyclical unemployment is an unfortunate yet natural part of the business cycle. At best, it is often temporary since it depends on the length of a recession’s economic contractions. Since 1945, typical recessions have lasted for 11 months on average. Once the business cycle returns to the expansionary phase, companies re-hire unemployed individuals.

A Deeper Understanding of Cyclical Unemployment

When people hear the word “unemployment,” they often think of an economic slow-down and businesses laying off workers to respond to the decrease in demand. Technically, this is just part of the cyclical unemployment definition, but there is a huge consideration for the labor market.

Companies hire labor because they need the manpower for production. Employees supply the labor to earn income. Together, they represent the supply and demand for labor.

Firms achieve equilibrium in the labor market when there is a balance between the quantity of labor supplied and the quantity of labor demanded.

A primary determinant for the labor demand from companies is their perception of the macro economy’s state. If a business owner believes that their business is expanding, then they will hire more people, which shifts the demand curve for laborers. On the other hand, if the company believes the economy is entering a recession or is in danger of slowing down, it will hire fewer laborers.

The variation in unemployment due to the economy’s movement from recession to expansion or expansion to recession is known as cyclical unemployment.

During a recession, the rate of cyclically unemployed people (also known as involuntarily unemployed) is high due to the decline in consumer demand for services and goods. In other words, since there is a decrease in production, fewer employees are needed, resulting in job layoffs.

How Can You Calculate Cyclical Unemployment Rates?

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The cyclical unemployment formula also accounts for other unemployment rates. The formula is:

Current Unemployment Rate – (Structural Unemployment Rate + Frictional Unemployment Rate) = Cyclical Unemployment Rate

Consider this example: During a recession, people are buying fewer cars, so the manufacturers don’t need to manufacture more vehicles to meet the demand. In line with this, they don’t need plenty of workers to meet the slow demand; therefore, they lay off their workers to cut labor costs.

However, when the economy starts gaining traction and consumers are willing to buy cars again, the laid-off workers may be re-hired to meet the growing demands. Thus, their unemployment is cyclical, relying on business cycles.

Cyclical unemployment is a form of seasonal unemployment but mostly a temporary type of unemployment. When the economy re-enters the business cycle, the unemployment rates continue to change.

What Causes Cyclical Unemployment?

As mentioned above, the current status of the economy and consumer demand plays a part in the cyclical unemployment rates. When consumer demand for services and goods drops, there is a reduction in production. The reduction lowers the need for employees, causing layoffs. Since consumers have less money to spend, businesses experience a loss of revenue. In turn, businesses must lay off their workers to maintain their finances.

In general, when cyclical unemployment starts, the economy is already in recession. Companies study the downturn first before they warrant layoffs. For example, a stock market crash causes many people to be cyclically unemployed. Previous economic crashes include 2008’s financial crash, 2000’s tech crash and the financial bomb of 1929. Stock market crashes cause recessions by instilling loss of confidence and panic in an economy.

In this case, businesses suffer a large amount of net worth due to the plummeting in stock prices. When the market dives, so will the opportunities for expansion and growth. Investors lose their confidence in the financial market. To protect their finances, they automatically sell their holdings. As a result, consumers will delay their purchases and wait to see if prices continue falling or if investor confidence returns.

Negative multiplier effects also cause cyclical unemployment. The multiplier effect refers to a chain reaction triggered by a reduction in demand. For example, a decline in the demand for chicken will not only affect the supermarket’s profits, but also the butcher, the farmer and the logistics side of the trade. Basically,  a decline in demand in one area will affect other areas. Taken into a wider scale, you’ll see the unemployment cycle multiplying through connected industries.

What are the Effects of Cyclical Unemployment?

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The effect of cyclical unemployment can be a self-fulfilling downward spiral. Companies driven by the falling demand will reduce their investments and lay off workers. As a result, the demand will fall further and businesses will become less efficient due to the huge reduction in productive capital.

Other effects of cyclical unemployment include the following:

Deflation

When the economy declines and unemployment rates rise, consumer demand drops, which can contribute to deflation. Since consumers demand less, businesses will lower their prices to attract more customers.

Falling Demand

Cyclical unemployment is the result of a declining economy, which is closely linked to falling demands for products and services. As the demand falls, companies need fewer laborers to meet the reduction in demand, which results in a decline in employment. However, the declining consumer demand leads to people losing their jobs, which affects their demand, too. As a result, their loss of demand will affect other jobs related to their needs.

Decreasing Productivity

Since consumers demand less, businesses take less money. As a result, companies are cutting costs instead of investing in more productive capital and machinery. At the same time, many companies will be overstaffed. For instance, a restaurant may have six waiters on duty but there only enough customers to require half of the workforce. As a result, the other three have nothing to do.

Declining Profits

Apart from the declining demand, businesses must also deal with cost pressures. They must reduce their manpower, which involves paying redundancies. They may also have to reduce prices to attract customers, which reduce profits. Good financial management can help for a while but in the long run, you will lose profits.

Solutions to Cyclical Unemployment

Since cyclical unemployment can spiral out of control, both businesses and the government must step in to stop it — mostly the government, though.

On the government side, spending is an important factor to consider, especially expansionary fiscal policies. Expansionary fiscal policy has two forms: lower taxation or increased government spending.

With reduced taxation, the government aims to put more money into the pockets of individuals. If consumers are taxed less, they have more disposable income. Some people may choose to spend the additional income while others will save it. No matter what they choose, the disposable income will have a stimulating effect on the economy. Depending on the tax cuts, they may stave off cyclical unemployment.

On the other hand, there’s increased government spending. This means higher taxes in the long run. When the government spends money on important projects, that money would filter into a wider economy, preventing a dramatic decline in demand. While this can stave off private sector funding, the taxes may compromise how the public spends their money.

Expansionary fiscal policies, however, can take time since congress must vote for the additional federal spending. The spending may raise the budget deficit.

Another government response is expansion monetary policy, which involves the Federal Reserve lowering interest rates to positively impact the economy. Lowering rates make credit card payments and loans more affordable, which can encourage spending. This will boost market confidence.

Cyclical unemployment is an unfortunate yet natural part of the business cycle. When a recession happens, it is almost inevitable. Still, the government and businesses can prepare for the season of cyclical unemployment in advance with the hopes of reducing the number of cyclically unemployed.

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