Cyclical unemployment is the component of unemployment typically associated with economic upturns and downturns. Naturally, unemployment increases during recessions or economic downturns and decreases during periods of strong economic growth. Cyclical unemployment along with other forms of unemployment such as structural unemployment, seasonal unemployment and others make up the general measurement of unemployment in the economy.
Cyclical unemployment is very sensitive to the ebbs and flows of economic growth. This is in contrast to things such as structural unemployment which is caused by more secular trends or fundamental shifts in the makeup of the economy. For instance, if you were a worker who developed film from cameras taken by individuals, you’re likely out of work as a result of smartphones and digital image libraries obliterating the personal camera market.
Frictional unemployment is typically categorized as joblessness as a result of individuals moving from one job to another. Structural unemployment refers to the level of unemployment caused by more structural issues such as minimum wage laws, unionization, discrimination and more.
What Causes Cyclical Unemployment?
In order to properly understand cyclical unemployment, a solid understanding of the business cycle is crucial. Economic growth and contraction typically doesn’t happen in linear fashion. Rather, economic growth is cyclical where it rises and falls instead of always going up or always going down.
When the business cycle is in an expansionary phase, unemployment tends to drop as businesses are producing or selling more goods and services which requires more labor and employees. On the flip side, when the business cycle is in a contractionary period, demand for a business’s goods and services might be dropping and the business may be employing more people than it needs. This leads to employees being let go and an increase in the unemployment rate.
Furthermore, you can think of cyclical unemployment being caused by excesses in the market. An example might be homebuilders. As economic growth is roaring, homebuilders are building more and more homes to meet demand for new homes. Homebuilders need lots of labor to build homes, so during this time period, they are hiring many workers. Eventually supply of new homes will catch up with demand either from over supply or declining demand. This often coincides with a turn in the overall business cycle. At the peak of a business cycle, we often see an excess of supply in the market for various goods. Companies need to cut production in order to get back to a proper balance of supply and demand, and this often takes the form of cutting employees.
Why Is Cyclical Unemployment Important?
Employment and unemployment are very important economic metrics that are closely watch by economists and policy makers.
Note that the Federal Reserve, for instance, has a dual mandate in which they seek price stability and full employment. So, Federal Reserve officials are setting monetary policy in accordance with attempts to achieve maximum employment.
Moreover, unemployment levels are perhaps one of the most closely followed economic metrics followed by the general public. While there are a number of important economic indicators such as GDP growth, inflation growth, etc., many of these numbers aren’t as easily understood as unemployment. And many of these indicators aren’t as greatly felt by the general public as unemployment. Simply put the public cares about jobs and unemployment. Therefore, politicians running for office care about unemployment.
As politicians, economists and policy makers closely follow unemployment, it’s important to understand the components that make up the unemployment numbers. Cyclical unemployment is a major contributor to unemployment, therefore it’s extremely important to a wide range of individuals (as well as the general public).
Where Do We See Cyclical Unemployment The Most?
While expansion and reduction of employee counts can be normal in every industry, cyclical unemployment is often more pronounced in what are referred to as cyclical industries. Common examples of cyclical industries are housing, automobile manufacturing, steel industries and other industries involved with highly discretionary purchases (think boating). These industries are more affected by the business cycle. They thrive during periods of economic growth and stagnate during periods of economic contraction.
In contrast, non-cyclical industries such as health care, education and drug manufacturing often don’t contribute as much to cyclical unemployment compared to the cyclical industries and businesses.
How is Cyclical Unemployment Different From Seasonal Unemployment?
Cyclical unemployment can often be confused with seasonal unemployment. However, whereas cyclical unemployment is strictly caused by the business cycle, seasonal unemployment refers to joblessness related to a seasonal change within the calendar year. Examples of seasonal unemployment might be a reduction in retail workers after peak holiday shopping season or fishing laborers being out of work in northern climates once the weather turns cold. Because seasonal unemployment is often anticipated, economists can properly smooth out seasonal causes of unemployment in what is referred to as seasonally-adjusted unemployment.
Is It Possible To Fix Cyclical Unemployment?
Cyclical unemployment and the effects of the business cycle in general are the target for much of fiscal and Federal Reserve policy. In one sense, halting the effects of a downturn in the business cycle and the rise of cyclical unemployment is one of the main areas of government intervention in the economy. This is done mostly through areas such as fiscal policy, monetary policy and unemployment assistance. Let’s look at each one of these briefly.
Fiscal policy refers to actions taken by the legislative and executive branches of government with respect to government spending. When it comes to a business cycle downturn, fiscal policy usually takes the form of fiscal stimulus. Fiscal stimulus usually means government spending that either has the primary purpose or secondary purpose of creating jobs.
Fiscal stimulus often takes the form of infrastructure spending. Think the construction of roads, bridges, tunnels and other things. Because construction workers are often near the top of the list in terms of areas of employment affected by an economic downturn, infrastructure spending has the benefit of aiding workers likely out of work (as well as assisting in the improvement of the nation’s infrastructure). A famous example of an infrastructure project during an economic downturn is the Hoover Dam which was commissioned during the Great Depression in the 1930s. Thousands of laborers were employed by this project.
Monetary policy is also used by the government in an attempt to smooth the business cycle and reduce the negative effects of cyclical unemployment. The Federal Reserve is responsible for setting monetary policy and the setting of interest rates is the primary mechanism by which the Fed does this. As an economy peaks and begins to head into a downturn, the Federal Reserve will often lower interest rates in an attempt to spur economic activity and counteract the contractionary forces. Often, the Fed will lower interest rates multiple times as an economic downturn persists.
In order to be able to lower interest rates, the Fed will often increase interest rates during periods of economic expansion. This serves two primary purposes. First, increasing rates can ensure inflation does not get out of control. Secondly, by raising rates, it ensures that the Fed has “ammunition” by which to fight the next economic downturn.
The Federal Reserve and monetary policy in general is the subject of much debate. While proponents of the Fed believe that it is instrumental in fighting the negative effects of the business cycle, critics of the Fed believe that the Fed’s policies actually cause the boom and bust business cycle in the first place. Plus critics also claim that monetary policy distorts markets forces which can lead to the formation of bubbles (that eventually pop).
Government also seeks to dampen the effects of cyclical unemployment by aid to unemployed workers in the form of unemployment benefits. This has the benefit of not only aiding people who might need help (which is politically advantageous), but this also puts money into the hands of people who may be more likely to spend the money they have (which spurs the economy).
Cyclical unemployment is an extremely important and widely followed economic indicator. It is closely followed by economists, politicians and policy makers. While there is widespread agreement that dampening the effects of cyclical unemployment is a worthy goal, there is much less consensus on how to achieve such a goal. Moreover, as with many subjects today, the matter often gets highly politicized which makes it tougher to have reasonable and practical debates about the best strategies to limit cyclical unemployment and achieve more longer-term and sustainable economic growth.