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Understanding Cyclical Unemployment & Its Effects

written by: Ginny Edwards•edited by: Jean Scheid•updated: 9/8/2010

While cyclical unemployment is a normal economic condition due to the fluctuations of the business cycle, severe shocks in the economy can cause unprecedented deviations from the normal cycle that employees and businesses need to understand.

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    The Normal Cycle of Rising and Falling Unemployment

    Cyclical Unemployment 

    Cyclical unemployment, which naturally gravitates between full employment levels and higher levels of unemployment is the direct result of the variations in the demand and supply for goods and services as seen in the gross national product (GDP). Full employment is achieved when people who are actively seeking jobs are able to find them readily without having to significantly retool their skills. At full employment, there is still technically unemployment but it is relatively low (4 to 5 percent) and represents frictional employment where people are transitioning between jobs.

    Cyclical unemployment occurs periodically when consumer demand for goods and services tapers off for a variety of reasons and businesses start a round of layoffs as the fastest and most economical way to reduce costs to remain profitable or at least viable until demand returns. Cyclical unemployment returns to full employment levels when aggregate demand and consumer confidence pick up and businesses begin to rehire.

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    Disruptions to Cyclical Unemployment

    Because cyclical unemployment is directly linked to the business cycle, its duration often tracks the downturn of the business cycle, commonly known as a recession. According to the National Bureau of Economic Research, the 10 previous postwar recessions ranged in length from 6 months to 16 months, averaging about 10.5 months. Until the recent recession, business cycles had actually shortened since the postwar period because of the vigilant intervention of the Federal Reserve to lower interest rates, which nudges up demand by encouraging investment and innovation and lowering the cost of borrowing to consumers that enable them to make more expensive purchases. However, in the latest recession, monetary policies have not been as effective in lowering unemployment and increasing steady consumer demand. Several factors were and continue to be disrupting the normal cycle from returning to full employment levels, including:

    1. Initial panic large-scale layoffs in response to the fear of an imminent financial collapse, causing consumers to literally stop spending as they assumed that they would be next in losing their jobs.
    2. Deep contraction of credit extension that stifled small businesses from expanding and hiring.
    3. Increased reliance on productivity gains to compensate for the shrinking workforce which enabled businesses to put off hiring.
    4. Permanent downsizing and a shift toward the use of temporary workers, eliminating the need to pay certain benefits that subtract from the bottom line.
    5. Complete disappearance of certain jobs, such as in housing, that entered a black hole and have little chance of reemerging to reduce cyclical unemployment.
    6. Lingering uncertainty regarding fiscal policies affecting tax laws, health care, and regulatory policies that increase the cost of doing business.
    7. Sustained fractured incomes of the unemployed who could not participate in driving up demand because they could only afford the basic necessities.
    8. Simultaneous convergence of Baby Boomers hitting retirement age and realizing they don't have enough saved as they scramble to figure out what is the best state to retire to on a fixed income.
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    What Employers and Employees Need to Know

    Both employers and employees need to understand that when cyclical unemployment continues for a long period of time, there are lingering consequences for employers, employees, and employees' families. Even when employment does improve to healthier levels, "full employment" is likely to reset at higher levels in the range of 6 to 7 percent. What this means for workers is that the labor market will continue to remain competitive whether or not there is cyclical unemployment. The trend will affect all generations of workers. Baby Boomers will need to remain in the labor force longer as they attempt to make up for the "years of lost income" and the destruction of their household wealth. New entrants in the workforce, mostly represented by the Y generation will find themselves hugging the lower side of earnings curve in jobs that are less satisfying. For employers, as the employment situation eventually improves and employees become increasingly dissatisfied, employers will encounter a more mobile workforce ready to move on to better opportunities. Employers will need to craft greater incentives to retain these employees who originally took their jobs out of desperation instead of opportunity.

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    References and Image Credit

    National Bureau of Economic Research. www.nber.org (accessed September 4, 2010).

    Times, Andrew Ross Sorkin. The New York Times. "Why Wall Street Is Deserting Obama - CNBC." Stock Market News, Business News, Financial, Earnings, World Market News and Information - CNBC. http://www.cnbc.com/id/38933555 (accessed September 4, 2010).

    Image Credit: renjith krishnan / FreeDigitalPhotos.net