Inflation, GDP and Labor Market

Inflation

Economic Indicators

The Big 3 Economic Indicators (Inflation, GDP and Labor Market)

Consumer Price Index (CPI)
Economic System

Inflation

Inflation - During a period of inflation, when prices are increasing throughout a country's economy, any given amount of money buys less than it did before. At such times, lenders try to protect their incomes by rais­ing interest rates. In addition, many people are less able to save money, and so lending institutions may have less money to lend. Therefore, the amount available for loans decreases and interest rates rise.

Economic activity - When the economic activity of a country increases—that is, when consumers buy more than previously—businesses expand their production capacity. They might buy new equipment or increase the supply of raw materials they have on hand. To fi­nance this expansion, they borrow. Therefore, the de­mand for loans increases and interest rates also rise. When the economy slows down—that is, when consum­ers buy less—businesses produce less and borrow less. The demand for loans is reduced and interest rates are much lower.

Inflation is a continual increase in prices throughout a nation's economy. The rate of inflation is determined by changes in the price level, an average of all prices. If some prices rise and others fall, the price level may not change. Therefore, inflation occurs only if most major prices go up.

Inflation reduces the value also called the purchas­ing power of money. During an inflationary period, a certain amount of money buys less than it previously did. For example, a worker may receive a salary increase of 10 per cent If prices remain stable, the worker can purchase 10 per cent more goods and services. How­ever, if prices also increase 10 per cent, the worker's purchasing power has not changed. If prices increase more than 10 per cent, the worker cannot buy as much as he or she previously could.

Inflation has many causes. It may result if consumers demand more goods and services than businesses can produce. Inflation may also occur if employers grant wage increases that exceed gains in productivity. The employers pass most or all of the cost of the wage in­crease along to consumers by charging higher prices. A government can try to control inflation by increasing taxes, decreasing the money supply, reducing govern­ment spending, and setting limits on wages and prices. But the government is faced with difficult decisions, chiefly because it may trigger a recession when it tries to reduce inflation.

Hyperinflation is rapid, uncontrolled inflation that destroys a nation's economy. Money loses its value, and many people exchange goods and services instead of using currency. Hyperinflation occurs when a govern­ment spends much more money than it receives in taxes. The government then borrows or prints additional money in order to pay for the goods and services it needs. The increased demand for these items causes an overall increase in prices. The government then may have to print even more money to pay its expenses. The vast amount of money in circulation causes its value to drop sharply.

Hyperinflation has ruined the economies of some na­tions during or after wars. It caused the collapse of the German economy after World War I ended in 1918. The German government printed large amounts of currency to finance itself after the war. As a result, prices in Germany increased more than 1 trillion per cent from Au­gust 1922 to November 1923.

Theories about the causes of inflation

Economists have various theories that attempt to ex­plain why inflation occurs. Many factors contribute to in­flation. One element that is almost always present is an increase in a nation's money supply, which either causes or eases the increase in prices.

Inflation occurs during many wars and periods of re­construction that follow wars. At such times, a nation's economy operates at full capacity, and the demand for goods and services exceeds the supply. This situation causes prices to increase.

The quantity theory states that inflation results when the demand for goods and services exceeds the supply. Such a situation occurs because the money sup­ply increases faster than the rate at which goods and services are produced. Increased demand causes prices to increase, resulting in so-called demand-pull inflation.

The Keynesian Theory, developed by the British economist John Maynard Keynes, also focuses on ex­cess demand as the cause of inflation. Keynes believed that increased demand for goods and services should be met by expanded production. However, after a na­tion's economy reaches full capacity, production cannot -| expand. If the demand for goods and services increases, if prices continue to rise and inflation occurs. In such cases, Keynes recommended a tax increase, which would reduce the demand for goods and services and | relieve the pressure on prices.

The cost-push theory. When businesses raise their prices in response to cost increases, cost-push inflation results. Workers then may demand higher wages to keep up with rising prices, and a wage-price spiral occurs. If wages and prices increase but production does not, the supply of goods and services cannot meet the demand for those items.

Cost-push inflation also occurs if a limited number of businesses control the supply of certain products. A mo­nopoly exists if one business controls an entire industry.

In an oligopoly, so few companies provide a product or service that each of the firms can influence the price - with or without an agreement among them. In such con­trolled industries, consumers must buy from a limited number of sellers at prices set by the controlling firms. But if competition is intense, each firm tries to offer a better or cheaper product than the others.

In addition, cost-push inflation results if several firms form a cartel, a group of businesses that functions as a monopoly. A cartel may limit the supply of a certain product, such as oil or copper, to drive prices up and thus earn higher profits. If that product is used to make other goods, the cost of those items will also rise.

The expectations theory is based on the belief that prices will increase. When prices rise at a certain rate, people expect them to keep going up at that rate or even faster. Many workers attempt to keep ahead of the expected increases by demanding higher wages. Some unions bargain for contracts that include escalator clauses or cost-of-living allowances. These provisions call for periodic wage increases that keep pace with changes in price indexes. Such increases also contribution to rising prices.

Fiscal policy of a nation is reflected by the govern­ment's spending and taxing programmes. The govern­ment can use these programmes to reduce the demand for goods and services. The government can accomplish this goal by reducing its own spending. If the govern­ment buys less from businesses, sales go down and people have less money to spend. The government can also reduce the spendable income of consumers by raising taxes. If consumers spend less money, the de­mand for goods and services decreases and prices level off.

Many people object to fiscal policy as a means of controlling inflation. They oppose a reduction in govern­ment spending because the funds involved help provide education, health care, and other services. No one wants to pay higher taxes, and a sharp reduction in demand often increases unemployment.

Monetary policy is the programme a nation follows to regulate its money supply. The monetary policy is controlled by the nation's central bank. In Britain, it is the Bank of England; in the United States, the Federal Reserve Board. Most of the nation's large commercial banks belong to the central bank. The central bank de­termines the amount of money that most deposit-taking institutions must have in their vaults or as deposits. This amount is called a reserve requirement.

The central bank can try to reduce the rate of inflation by decreasing the money supply and thus adopting a tight money policy. It also may increase the money sup­ply by following an easy money policy.

The central bank may decrease the money supply by raising its reserve requirement. This limits the amount of money banks can lend. Fewer loans are granted, and so people have less money to spend. Thus, the demand for goods and services decreases, and prices rise more slowly. If the central bank wants to increase the money supply, it lowers its reserve requirement.

The central bank also may decrease the money supply by selling government bonds. The purchasers pay for the bonds with cheques drawn on their banks. When the banks pay these cheques, their reserves are re­duced. The banks make fewer loans, and so the money supply shrinks and the rate of inflation decreases.

Wage and price controls are set by a government to limit wage and price increases during an inflationary period. When a wage-price spiral occurs, wages and prices increase continually to keep up with each other. Some economists believe that by limiting these in­creases, wages and prices will eventually level off.

Many economists consider wage and price controls Ineffective because such limits are difficult to establish and hard to enforce. Others believe wage and price con­trols interfere with the natural rise and fall of wages and prices. Related articles: Business cycle, Price, Consumer Price Index, Price control, Cost of living, Supply and demand, Money, Unemployment (Fighting unemployment) and Mortgage.

  

Gross domestic product (GDP)

Leading countries in per capita gross domestic product.

Leading countries in total gross domestic product.

Gross domestic product (GDP) is the value of all goods and services produced in a country during a given period. It is one of the most widely used measures of a nation's total economic performance in a single year.

Measuring the GDP. One way to determine the GDP is to add up the sum of spending on four kinds of goods and services in any year.

(1)Personal consumption expenditures include pri­vate spending on durable goods, such as cars and household appliances; nondurable goods, such as food and clothing; and services, such as haircuts and cinema tickets.

(2)Private investment expenditures include spending by business companies for new buildings, machinery and tools. They also include spending for goods to be stored for future sale.

(3)Government purchases of goods and services in­clude spending for new roads, railways, armaments, and the wages of teachers, fire fighters, and government employees.

(4)Net exports represent the value of domestically produced goods and services sold abroad, less the value of goods and services purchased from abroad during the same period.

Real GDP. A nation may produce the same amount of goods and services this year as it did last year. Yet this year's GDP may be 5 per cent higher than last year's. Such a situation would occur if prices of goods and services had risen by an average of 5 per cent. To adjust for such price changes, economists measure the GDP in constant prices. They determine what each year's GDP would be if a nation's currency was worth as much dur­ing the current year as in a certain previous year, called the base year. In other words, they calculate the value of each year's production in terms of the base year's prices. For example, between 1980 and 1990, a country's pro­duction in current prices might have risen by 110 per cent; but if allowance is made for the change in prices, in constant prices the increase may be only 30 per cent since 1980. When GDP measured in current prices is di­vided by GDP in constant prices, the result is an index of inflation called the GDP deflator.

Interpreting the GDP. GDP figures, though only esti­mates, are useful. Business people, economists, and government officials study them to help determine how fast the economy is growing and which parts of it are doing best. The figures also show how the economic performance of one country compares with that of other nations.

There are many different reasons a country's GDP may not grow fast. An economy which depends heavily on agriculture, such as that of India, only needs a bad drought to slow down its overall economic growth. A country which depends on selling its products abroad will suffer badly if world trading conditions are very bad one year. Inflation or an inefficient workforce may also prevent GDP rising as fast as it should.

The United States has long had the highest GDP of any country, but it no longer has the highest GDP per capita (for each person). The GDP per capita can be de­termined by dividing the total GDP by the nation's popu­lation. In addition, the United States no longer has the fastest-growing GDP. The GDP in constant prices has doubled about once every 20 years since 1900. But this growth has been uneven. A severe decline occurred during the early 1930's, and a sharp rise took place dur­ing World War II (1939-1945). The GDP of the United States has risen almost every year since 1950, but the growth rate has varied.

GDP figures do not tell everything about a nation's economy. For example, they tell little about the well­being of individuals and families. Even the GDP per cap­ita does not tell who uses various goods and services. It cannot show, for example, how much of the GDP goes to the poorest 20 per cent of the population and how much goes to the wealthiest 20 per cent. In countries where GDP per capita is very low, there may be some extremely rich people. In countries where GDP is very high, there may be some very poor people. Also, GDP gives no indication of the buying power in individual countries. In the United Kingdom, for example, the price of a car would buy at least one house in India. GDP per capita also does not tell anything about the quality of a country's goods and services.

GDP excludes production by facilities that are owned by a nation's citizens if the facilities are in another coun­try, and it includes production by foreign-owned facili­ties within the country. Some economists believe an­other figure, the gross national product (GNP), is a better measure than GDP. GNP includes all production by a na­tion's firms regardless of the firms' location and does not include production by foreign-owned facilities within the country.

Communist countries, in which the government con­trols the economy, use a figure called net material prod­uct (NMP). NMP shows the total value of goods pro­duced and of services used in manufacturing the goods in a year. It does not include financial, governmental, personal, and many other services.

See also Inflation; National debt; National income; Standard of living (table). Gross national product (GNP). See Gross domes­tic product (GDP).

The labor Market

The last major factor influencing the economy is the labor market. The key indicators most investors focus on here are total employment and the unemployment rate. US citizens who are already working represent the employed, while those who are actively looking for work, but haven’t found it yet, are the unemployed. The unemployment rate does not include people without jobs who are not looking for jobs, such as students, retirees, or people who are discouraged and have simply given up trying to find a job.

The Employment Report is published monthly by the US Department of Labor, and provides both the employment and unemployment numbers. There is always some unemployment. As the allocation of resources change in the economy, based on what people are buying, some companies go out of business while others that produce the things that are in demand will be expanding. This allows a flow of labor from losing to winning industries but it is not an instantaneous process. Others may leave their jobs by choice. That means there is always some amount of unemployment built into the economic structure, which is often termed the “natural” level of unemployment.

The natural level of unemployment is the point where any drop below that figure creates conditions that will drive up inflation (as companies bid up wages to attract the scarce workers). There is always some disagreement as to what the “natural” level of unemployment is for the US economy. For one thing, it changes over time as the nature of the economy changes. For most of the 1980’s, it was often estimated at about 6%, although most economists now feel it is probably around 5%, or even the high 4’s.

What might cause this kind of change? A paper a couple years ago from the Brookings Institute cited some factors that they estimated have reduced the natural rate by about 1%. Accounting for about 0.4% of that is the aging of the population; older people tend to be more fully employed. The growth of temporary staffing firms that rapidly match job-seekers with employers could account for 0.2-0.4%. Finally, the doubling of the prison population probably accounts for about 0.2% of the reduction, by removing from the labor force people who are less likely to be employed.

Unemployment - Unemployment is the state of a person who is out of work, and actively looking for a job. The term unem­ployed does not refer to people who are not seeking work because of old age, illness, or a mental or physical disability. Nor does it refer to people who are attending school or keeping house. Such people are generally classified as being "out of the labour force."

Unemployment may involve serious problems for an individual, and for society as a whole. For the individual, it means loss of income, and prolonged unemployment may result in a loss of self-respect. For society, unem­ployment can lead to lost production, and, in some cases, to criminal or other antisocial behaviour.

Normal unemployment exists in efficiently operat­ing labour markets, even when jobs are plentiful. Such

unemployment includes workers who have left their jobs or have been fired and have not yet started a new' job. It includes other individuals, such as young people and former homemakers, who have not recently been employed but are now seeking a job. This is called short-term unemployment.

Another kind of normal unemployment, called sea­sonal unemployment, occurs in industries that lay off workers during certain seasons each year. Such indus­tries include agriculture, construction, and shipping. For example, because Canada has long, cold winters, sea­sonal unemployment there is a much more serious problem than it is in many warmer countries.

Structural unemployment exists when individuals seeking work have the wrong skills for the available jobs. For example, construction labourers may be seek­ing work at a time when there is a shortage of secre­taries and computer programmers. Structural unem­ployment also includes people who live in areas where jobs are scarce, while jobs are plentiful elsewhere.

Structural unemployment includes technological un­employment. This results from the development of new products, machinery, or manufacturing methods. Such developments call for new skills from workers. The total number of employment opportunities may not fall, but the number of jobs in certain occupations may grow less rapidly than in others or may even decline.

Deficient demand unemployment results from a general lack of demand for workers. This happens when a nation's total spending is too little. When goods and services remain unsold, many industries reduce produc­tion, and lay off employees. Alternatively, industries can attempt to maintain production and employment levels by reducing both prices and wages.

Deficient demand unemployment is called cyclical unemployment when it occurs in periods of decreased business activity. But it also can occur in times of in­creasing activity if the number of workers grows faster than the number of jobs.

in the 1930's, during an economic slump known as the Great Depression, unemployment increased rapidly in many countries. In Canada, Germany, and the United Kingdom, for example, unemployed people accounted for about 13 to 20 per cent of the labour force. In the United States, 25 per cent of people who wanted work could not find jobs in the early 1930's. The American un­employment rate remained above 14 per cent until 1940. After the United States entered World War II in 1941, and its government spent huge amounts of money for military purposes, the unemployment rate dropped. It was only 1.2 per cent by 1944.

Unemployment statistics. Economists disagree on the meaning of unemployment rate, the statistic showing the proportion of people who are unemployed.

Some believe the rate exaggerates the problem because it includes some people who want only part-time jobs, and also some who are not making serious efforts to find a job. Others argue that the rate underestimates the problem because it does not include discouraged work­ers who have stopped looking for jobs, or workers who have taken jobs below their skill level.

Economists point out that countries use different ways to count the unemployed. Also, a single unemploy­ment statistic for a country does not reveal how much unemployment may vary among different groups of people. For example, unemployment rates tend to be higher for younger people than for older people. Un­skilled labourers experience much more unemployment than do skilled workers and white-collar employees. Some groups of people suffer employment discrimina­tion because of their race, religion, language, national origin, or other characteristics.

Full employment. In 1941, a proposal in the UK, the Beveridge Plan, called fora policy of full employment. Full employment means that jobs are available for any­one who wants to work. Under this policy, when busi­ness and industry cannot provide enough jobs, the gov­ernment must take action to create jobs. Many industrial countries have had such a policy, it found little support in the United States, or other countries where govern­ments favoured a free-market economy.

Full employment policies aim at unemployment rates as low as 3 to 4 per cent, so that the only unemployment is structural or short-term. Some economists argue that higher unemployment rates might be necessary to hold inflation (rising pricesl in check.

Insurance schemes. Unemployment insurance is a means of providing income support for workers who are out of work and looking for employment The unem­ployed workers receive cash payments, usually each week for a limited period. Most industrial countries have unemployment insurance systems.

The first known unemployment insurance plan was adopted in Basel, Switzerland, in 1789. Afterward, sev­eral trade unions in the United States and Europe adopted voluntary plans. Such plans helped able-bodied wage-earners who were temporarily out of work through no fault of their own.

In 1911, the UK set up the first compulsory unemploy­ment insurance system. After World War I (1914-1918), the UK system began paying various types of allow­ances, commonly called the dole, to unemployed work­ers. About 40 countries, mostly in Europe, North Amer­ica, and Australia, have similar schemes.

World summary. World employment and unem­ployment statistics are reported regularly by the Interna­tional Labour Office of the International Labour Organi­zation. Low unemployment rates have been maintained in some countries. Sweden had under 2 per cent em­ployment in the late 1980's, and Japan's rate was under 3 per cent. Labour shortages in Japan and in Singapore (under 5 per cent unemployment) helped these coun­tries to hold down unemployment. In the United States, a recession in the early 1980's caused a sharp rise to 10.8 per cent, the highest since 1941. The U.S. rate remained near 5 per cent in the late 1980's.

Countries which had rates between about 5 and 10 per cent in the late 1980s included Australia, Canada, Is­rael, the Philippines, South Africa, and the United King­dom. Malaysia had an unemployment rate of 8 per cent, but the country enjoyed a surge in prosperity.

Nations with rates higher than 10 per cent in the late 1980s included India and Ireland. Ireland's rate was more than 17 per cent, and a large number of people decided to leave the country and seek work elsewhere.

By the end of the 1980's, the unemployment rate among the 24 countries of the OECD (Organization for Economic Cooperation and Development), in Western

Europe, North America, and the Pacific area, was about 7 per cent. This was the same level the countries experi­enced at the start of the 1980"s.

See Poverty; Social welfare. See also sections on economy and on social welfare in World Book articles on countries.