Virtually everyone knows what unemployment means or what it stands for. However, several different factors contribute to the overall unemployment rate. One reason for overall unemployment is regular fluctuations in economic activity that result in cyclical unemployment.
Cyclical unemployment is practically unavoidable due to its close correspondence with economic activity, but understanding how it works can give you an investing advantage.
Cyclical unemployment is a type of unemployment that occurs when the overall demand for products and services in an economy doesn’t support full employment. Cyclical unemployment usually occurs during periods of slow economic growth or during economic recessions.
Understanding Cyclical Unemployment
Cyclical unemployment relates to growth and production cycles within an economy. These cycles regularly fluctuate back and forth. Expansions turn to recessions, recessions than recover into expansions, and so on.
According to economists, cyclical unemployment occurs because there is a lower demand for labor. During a downturn, employers often can’t afford to hire new people because their profits are being squeezed by the recession.
When the economy takes a downturn, there is less demand for products and services. As a result, the supply side reduces its production capacity. As production capacity is reduced, there is less need for labor. Surplus employees are usually laid off and subsequently join the ranks of the unemployed.
Unfortunately, this problem tends to compound itself. Rising unemployment rates tend to add to the economic despair of a recession. As more people lose their jobs, there is less money to buy goods and services, so it puts more stress on the demand side of the economy. In turn, falling demand adds more pressure to the supply side and so on. Eventually, it leads to further declines in economic activity.
Examples of Unemployment Cycles
A famous example of this type of unemployment is the housing bubble of 2008. Following the housing bubble and the Great Recession of 2008, more borrowers couldn’t pay up the debt obligations connected to their homes. As a result, new housing loans became harder to get and demand new construction dropped.
The drop in new construction further led to a decline in the number of workers. Due to the recession and borrowers unable to meet up with their obligations, around 2 million workers in the construction industry were out of jobs. This is a typical example of cyclical unemployment.
The economy began to recover over time, and more loans were made available to people. Thus, people began to build new homes, offices, remodeling, and more. The construction jobs returned to meet the increase in real estate demand. Thus, resulting in the decline of cyclical unemployment.
Other Types of Unemployment
According to economists, there are several types of unemployment. A few examples include structural, frictional, and institutional unemployment.
Frictional unemployment is a short-term loss of a job as a result of transitioning between one job and another. Structural unemployment is a result of the fundamental shifts in the composition of an economy. Meanwhile, institutional unemployment comes from institutionalized obstacles to employment, such as unionization, minimum wages, discriminatory hiring process, and more.
All the different types of unemployment factor into the overall unemployment rate. They can all occur simultaneously, even during an economic expansion. Understanding the factors behind the unemployment rate can help you get a better take on which way the economy is heading. These insights are extremely valuable for investors, and having that kind of foresight can generate big returns.
Cyclical Unemployment: Final Thoughts
Cyclical unemployment results from regular swings in the business cycle. However, it’s only one of the forces that factor into the overall unemployment rate. Modern economies are very multifaceted, so cyclical unemployment can occur during an expansion too. For example, one industry or sector can undergo a recession while the overall economy expands. It’s important to understand the factors that drive the employment rate if you want to be a prudent long-term investor.
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