Cyclical Unemployment

Unemployment due to the regular business cycle

What is Cyclical Unemployment?

Cyclical unemployment is a type of unemployment where labor forces are reduced as a result of business cycles or fluctuations in the economy, such as recessions (periods of economic decline). When the economy is at its peak or has continuous growth, the rate of cyclical unemployment is low, because during this period of production, sales and income increase, therefore, more people are needed to meet the demand. On the other hand, during a recession, the rate of cyclical or involuntary unemployment is high, due to the decline in consumer demand for goods and services. In other words, there is a decrease in production – therefore, fewer workers are needed, resulting in job layoffs. The number of unemployed workers exceeds the number of job vacancies in the labor market.

 

Cyclical Unemployment problem

 

How to Determine the Cyclical Unemployment Rate?

The formula for the cyclical unemployment rate accounts for the other two types of unemployment and the unemployment rate as well. The formula is as follows:

Cyclical unemployment rate  =  Current unemployment rate – (Frictional unemployment rate + Structural unemployment rate)

One concrete example of cyclical unemployment is when an automobile worker is laid off during a recession to cut labor costs. During this downturn, people are buying fewer vehicles, so the manufacturer doesn’t need as many workers to meet the demand. But when the economy starts to power up again and consumers begin to spend more money on buying vehicles, the unemployed worker may be rehired to meet the demand. Thus, his or her unemployment is cyclical, dependent on business cycles.

High or low cyclical unemployment is only temporary. When the economy enters and re-enters business cycles, the rate of unemployment continuously changes. The typical time frame for a business cycle during a recession may be only 18 months or so, but when the economy dips down into a depression, the cycle could take 10 years or more to be completed.

 

What is the Unemployment Rate?

The unemployment rate is the percentage of the total labor force that is unemployed but actively seeking employment. The current figures for employed and unemployed individuals can be obtained from the National Statistics Agency or the Bureau of Labor Statistics offices. The unemployment rate is important, as it is economically linked to inflation and interest rates.

 

What is the Frictional Unemployment Rate?

The frictional unemployment rate is the percentage of the total labor force that is voluntarily unemployed due to workers’ decisions to transition careers. A worker could be making a transition from one job to another or choosing to be temporarily unemployed while looking for a job that better matches his/her skills, income needs, location, or other factors. To calculate the rate, the total number of frictional unemployed workers is divided by the total labor force, then multiplied by 100 to yield a percentage figure. The current, accurate figures for frictional unemployed workers and the total labor force can be obtained from the National Statistics Agency or the Bureau of Labor Statistics.

 

What is the Structural Unemployment rate?

The structural unemployment rate is the percentage of the total labor force that is involuntarily unemployed due to mismatched skills, technological changes, business competition, or government policies. Figures for the structurally unemployed workers and the total labor force can be obtained from the National Statistics Agency or the Bureau of Labor Statistics.

 

What are the Causes of High Cyclical Unemployment?

Usually, cyclical unemployment starts to climb when consumers’ demand for goods and services begins to decrease. This, in turn, results in a decline of business revenue, which may prompt companies to lay-off workers to maintain profit margins. Often, the economic event that triggers such a cycle is a stock market crash. A market crash can cause a recession brought on by investor/consumer panic and loss of confidence in the economy. Consumers begin to delay purchases until market confidence is regained.

 

How Does the Government Address the Issue of Cyclical Unemployment?

The initial solution taken by the government to solve the issue of climbing a cyclical unemployment rate is to use an expansionary monetary policy. This policy is implemented by the central banks to energize the economy. Central banks will create money to buy government securities from the market in order to lower interest rates and increase the money supply. These economic conditions will then, hopefully, trigger financial institutions to promote an increase in lending and to make the money supply more liquid.

 

Learn More

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To continue learning and advance your career, see the following free CFI resources:

  • All economics articles
  • Macroeconomic interview questions
  • Zero sum game
  • Financial modeling guide

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!