Cyclical and structural unemployment in a recovering economy



Cyclical and structural unemployment

In 2014, the unemployment rate fell faster than the Fed expected. However, Fed officials don’t agree on what caused the decline. They also have different opinions on how to address the issue.

Before we discuss Fed Chair Janet Yellen’s views on the current state of the labor market, we’ll walk you through some of the concepts that Fed officials talk about when they’re assessing the labor market recovery.

The Fed would look at these key indicators, before contemplating raising rates. Markets watch signals for an increase in the federal funds rate.

An increase has important implications for both stock (SPY) and bond (TBT) investors. A rate hike would impact returns on exchange-traded fund (or ETF) investments including Treasuries (TLT), high-yield bonds (JNK), and corporate investment-grade bonds (LQD).


Cyclical and structural unemployment

A major disagreement among Fed economists is how to classify unemployment in the economy. Unemployment can be caused by cyclical or structural factors.

Cyclical unemployment occurs during an economic downturn. Businesses cut jobs because of slumping sales. When the economy recovers, these workers join the workforce again.

Article continues below advertisement

The Fed aims to stimulate business investment by keeping rates low. It also stimulates investment through its monthly bond buying program. Low rates allow cheap sources of investment funds. Additional liquidity would also make credit market conditions more favorable. Jobs are created when firms increase investment in the economy.

Structural unemployment occurs when job openings aren’t filled. Jobs aren’t filled because there’s a lack of qualified candidates. This usually occurs as a result of technological change. Workers need to upgrade their skills to meet employer requirements. Structural unemployment can’t be remedied through appropriate monetary policy.

A number of Fed officials, including Janet Yellen, believe that there’s evidence of significant “labor market slack.” This is caused by cyclical factors. The Fed’s policy must be accommodative—for example, keeping a low federal funds rate—to address it.

What’s labor market slack? We’ll discuss the concept in the next part of the series.


More From Market Realist