What is cyclical unemployment?
Cyclical unemployment is the component of overall unemployment that results directly from cycles of economic upturns and downturns. Unemployment generally increases during recessions and declines during periods of economic expansion. Moderating cyclical unemployment during recessions is a major motivation behind the study of economics and the focus of the various policy tools that governments employ to stimulate the economy.
Key points to remember
- Cyclical unemployment is the impact of recession or economic expansion on the total unemployment rate.
- Cyclical unemployment generally increases during recessions and decreases during phases of economic expansion and constitutes a major focus of economic policy.
- Cyclical unemployment is one of many factors that contribute to total unemployment, including seasonal, structural, frictional and institutional factors.
Understanding Cyclical Unemployment
Cyclical unemployment refers to erratic ups and downs, or cyclical trends in growth and output, as measured by the gross domestic product (GDP), which occur in the business cycle. Most business cycles eventually reverse, with the downturn turning into a recovery, followed by another downturn.
Economists describe cyclical unemployment as the result of companies not having enough job application to employ anyone looking for work at this point in the business cycle. When demand for a product and service declines, there may be a corresponding reduction in supply output to compensate. As supply levels are reduced, fewer employees are needed to meet the lower production volume standard. Workers who are no longer needed will be laid off by the company, resulting in their unemployment.
When economic output falls, the business cycle is low and cyclical unemployment rises. Conversely, when business cycles are at their peak, cyclical unemployment will tend to be low, as there is a high demand for labor.
Example of cyclical unemployment
During the financial crisis of 2008, the real estate bubble burst and the Great Recession began. As more borrowers defaulted on debts associated with their homes and requirements for new loans became stricter, demand for new construction declined.
With the increase in the total number of unemployed and the increase in the number of borrowers unable to maintain payments on their homes, additional properties have been subject to foreclosures, leading to even weaker construction demand. As a result, around 1.5 million construction workers were left unemployed. This rise in unemployment was cyclical unemployment.
As the economy recovered in the following years, the financial sector returned to profitability and began to lend more. People started buying houses again or remodeling existing houses, which drove up house prices again. Construction jobs have returned to meet this renewed housing demand and cyclical unemployment has declined.
Several types of unemployment often exist at the same time.
Cyclical unemployment vs other types of unemployment
Rather than being caused by the ebbs and flows of the economic cycle, unemployment is caused by fundamental changes in the composition of the economy – for example, jobs lost in the buggy-whip sector once automobiles became dominant. This is a mismatch between supply and demand for certain skills in the labor market.
Frictional unemployment is short-term unemployment caused by the actual process of leaving one job to start another, including the time it takes to look for a new job. This naturally happens even in a stable and growing economy, and is actually beneficial, as it indicates that workers are looking for better positions.
Institutional unemployment includes the component of unemployment attributable to institutional arrangements, such as high minimum wage laws, discriminatory hiring practices, or high rates of unionization. It results from long-term or permanent institutional factors and incentives in the economy.
Seasonal unemployment occurs when demand shifts from one season to another. This category can include all workers whose jobs depend on a particular season. Official unemployment statistics will often be adjusted, or smoothed, to account for seasonal unemployment. This is called a “seasonal adjustment.”
For example, teachers may be considered seasonal, based on the fact that most schools in the United States cease or limit their activities during the summer. Similarly, construction workers living in areas where construction during the cold months is difficult may lose their jobs in the winter. Some retail stores hire seasonal workers during the winter holiday season to better handle increased sales, then release those workers after the holidays when demand drops.
In most cases, several types of unemployment coexist. With the exception of cyclical unemployment, the other classes can occur even at the peaks of business cycles, when the economy is assumed to be at or near full employment.