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Chapter 6 111
The Goals of Macroeconomic Policy

eliminate poverty”both within our own country and throughout the world. Much of
the earth™s population still lives in a state of extreme want. These unfortunate people
are far less interested in clean air and fulfillment in the workplace than they are in more
food, better clothing, and sturdier shelters.
All that said, economists concede that faster growth is not always better. One impor-
tant reason will occupy our attention later in Parts 2 and 3: An economy that grows too
fast may generate inflation. Why? You were introduced to the answer at the end of the
last chapter: Inflation rises when aggregate demand races ahead of aggregate supply.
In plain English, an economy will become inflationary when people™s demands for
goods and services expand faster than its capacity to produce them. So we probably do
not want to grow faster than the growth rate of potential GDP, at least not for long.
Should society then seek the maximum possible growth rate of potential GDP?
Maybe, but maybe not. After all, more rapid growth does not come for free. We have
noted that building more capital is one good way to speed the growth of potential GDP.
But the resources used to manufacture jet engines and computer servers could be used
to make home air conditioners and video games instead. Building more capital imposes
an obvious cost on a society: The citizens must consume less today. Saying this does not
argue against investing for the future. Indeed, most economists believe we need to do
more of that. But we must realize that faster growth through capital formation comes
at a cost”an opportunity cost. Here, as elsewhere, you don™t get something for nothing.

We noted earlier that actual GDP growth can differ sharply from potential GDP growth
over periods as long as several years. These macroeconomic fluctuations have major impli-
cations for employment and unemployment. In particular:
When the economy grows more slowly than its potential, it fails to generate enough new
jobs for its ever-growing labor force. Hence, the unemployment rate rises. Conversely, The unemployment rate
is the number of unem-
GDP growth faster than the economy™s potential leads to a falling unemployment rate.
ployed people, expressed as
High unemployment is socially wasteful. When the economy does not create enough a percentage of the labor
jobs to employ everyone who is willing to work, a valuable resource is lost. Potential force.
goods and services that might have been produced and enjoyed by consumers are lost for-
ever. This lost output is the central economic cost of high unemployment, and we can
measure it by comparing actual and potential GDP.
That cost is considerable. Table 2 summarizes the idleness of workers and machines,
and the resulting loss of national output, for some of the years of lowest economic activity
in recent decades. The second column lists the civilian unemployment rate and thus meas-
ures unused labor resources. The third lists the percentage of industrial capacity that
U.S. manufacturers were actually using, which indicates the extent to
which plant and equipment went unused. The fourth column esti-
mates the shortfall between potential and actual real GDP. We see that
The Economic Costs of High Unemployment
unemployment has cost the people of the United States as much as an
8.1 percent reduction in their real incomes. Civilian Capacity Real GDP Lost
Although Table 2 shows extreme examples, our inability to utilize Unemployment Utilization Due to Idle
Year Rate Rate Resources
all of the nation™s available resources was a persistent economic prob-
lem for decades. The blue line in Figure 2 shows actual real GDP in the 1958 6.8% 75.0% 4.8%
United States from 1954 to 2007, while the black line shows potential 1961 6.7 77.3 4.1
1975 8.5 73.4 5.4
GDP. The graph makes it clear that actual GDP has fallen short of po-
1982 9.7 71.3 8.1
tential GDP more often than it has exceeded it, especially during the
1992 7.5 79.4 2.6
1973“1993 period. In fact:
2003 6.0 73.4 2.2
A conservative estimate of the cumulative gap between actual and SOURCES: Bureau of Labor Statistics, Federal Reserve System, and Congressional
potential GDP over the years 1974 to 1993 (all evaluated in 2000 Budget Office.

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Part 2
112 The Macroeconomy: Aggregate Supply and Demand

F I GU R E 2
Actual and Potential GDP in the United States since 1954






9,500 Actual GDP



Billions of 2000 Dollars



SOURCE: U.S. Department of Commerce and Congressional Budget Office.
Potential GDP


5,000 1982 “1983

1974 “1975
1960 “1961
1957“1958 Recession

1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007

prices) is roughly $1,750 billion. At 2007 levels, this loss in output as a result of unem-
ployment would be over one-and-a-half months worth of production. And there is no
way to redeem those losses. The labor wasted in 1992 cannot be utilized in 2007.

If these numbers seem a bit dry and abstract, think about the human costs of being unem-
ployed. Years ago, job loss meant not only enforced idleness and a catastrophic drop in in-
come, it often led to hunger, cold, ill health, even death. Here is how one unemployed
worker during the Great Depression described his family™s plight in a mournful letter to
the governor of Pennsylvania:
I have been out of work for over a year and a half. Am back almost thirteen months
and the landlord says if I don™t pay up before the 1 of 1932 out I must go, and where
am I to go in the cold winter with my children? If you can help me please for God™s
sake and the children™s sakes and like please do what you can and send me some
help, will you, I cannot find any work. . . . Thanksgiving dinner was black coffee and
bread and was very glad to get it. My wife is in the hospital now. We have no shoes
to were [sic]; no clothes hardly. Oh what will I do I sure will thank you.2

From Brother, Can You Spare a Dime? The Great Depression 1929“1933, by Milton Meltzer, p. 103. Copyright 1969

by Milton Meltzer. Reprinted by permission of Alfred A. Knopf, Inc.

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

Chapter 6 113
The Goals of Macroeconomic Policy

Nowadays, unemployment does not hold quite such terrors for most families, although
its consequences remain dire enough. Our system of unemployment insurance (discussed
later in this chapter) has taken part of the sting out of unemployment, as have other social
welfare programs that support the incomes of the poor. Yet most families still suffer
painful losses of income and, often, severe noneconomic consequences when a bread-
winner becomes unemployed.
Even families that are well protected by unemployment compensation suffer when
joblessness strikes. Ours is a work-oriented society. A man™s place has always been in the
office or shop, and lately this has become true for women as well. A worker forced into
idleness by a recession endures a psychological cost that is no less real for our inability to
measure it. Martin Luther King, Jr. put it graphically: “In our society, it is murder, psy-
F I GU R E 3
chologically, to deprive a man of a job. . . . You are in substance saying to that man that
he has no right to exist.“3 High unemployment has been linked to psychological and
Rates for Selected
physical disorders, divorces, suicides, and crime.
Groups, 2007
It is important to realize that these costs,
whether large or small in total, are distributed
most unevenly across the population. In 2007, 40
for example, the unemployment rate among
35 33.8
all workers averaged just 4.6 percent. But, as
Figure 3 shows, 8.3 percent of black workers 30
were unemployed. For teenagers, the situation

was much worse, with unemployment at 15.7
percent, and that of black male teenagers a 20
shocking 33.8 percent. Married men had the 15.7
lowest rate”just 2.5 percent. Overall unem-
SOURCE: Bureau of Labor Statistics.

ployment varies from year to year, but these 10 8.3
relationships are typical:
In good times and bad, married men suffer
the least unemployment and teenagers suf- Black
Blacks Teenagers
fer the most; nonwhites are unemployed Teenagers
much more often than whites; blue-collar
workers have above-average rates of unem-
ployment; well-educated people have be-
low-average unemployment rates.4

It is worth noting that unemployment in the United States has been much lower than
in most other industrialized countries in recent years. For example, during 2006, when the
U.S. unemployment rate averaged 4.6 percent, the comparable figures were 5.5 percent in
Canada, 9.5 percent in France, 6.9 percent in Italy, and 10.4 percent in Germany.5

We have been using unemployment figures without considering where they come from
or how accurate they are. The basic data come from a monthly survey of about 60,000
households conducted for the U.S. Bureau of Labor Statistics. The census taker asks
several questions about the employment status of each member of the household and,
on the basis of the answers, classifies each person as employed, unemployed, or not in the
labor force.

Quoted in Coretta Scott King (ed.), The Words of Martin Luther King (New York: Newmarket Press; 1983), p. 45.

Unemployment rates for men and women are about equal.

The numbers for foreign countries are based (approximately) on U.S. unemployment concepts.


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