6. Nation\'s Economic Pain Deepens A spike in the unemployment rate - the bigges

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6. Nation's Economic Pain Deepens
A spike in the unemployment rate - the biggest in more than two decades - raised new concerns Friday that a weak labor outlook, high oil prices and continuing woes in the housing and credit markets are leading the U.S. economy into a painful recession. The government said Friday that the unemployment rate soared to 5.5% in May from 5% in April - much higher than economists had forecast. The surge marked the biggest one-month jump in unemployment since February 1986, and the 5.5% rate is the highest level since October 2004. Unemployment is now a full percentage point higher than it was a year ago...CNN, June 6, 2008

a. How does the unemployment rate in May compare to the unemployment rate during the past few recessions?
b. Why might the unemployment rate tend to actually underestimate the unemployment problem, especially during a recession?
c. How does the unemployment rate in May compare to the estimated natural unemployment rate? What does this imply about the relationship between real GDP and potential GDP at this time?

Explanation / Answer

a) The unemployment rate in May is very similar to the initial unemployment rates for the past few recessions. Although, as things got worse, the past few recessions had a higher average and peak unemployment rate, by at least 1.5 percentage points. Comparing the average unemployment rate of the past few recessions and the one in May, we see that May's unemployment rate is smaller. b) The unemployment rate may underestimate the unemployment problem, because many workers may have been switched to part-time but are still listed as employed. In reality, these workers are underemployed, and many may be overqualified for the job or job hours they are currently working. Especially during a recession, companies will cut job hours and switch workers to part-time. So while technically still employed, these workers are considerably underemployed. c) The natural rate of unemployment is around 4.8-5%, so the unemployment rate in May is higher that the naturally occurring unemployment rate. This implies that real GDP is smaller than potential GDP, and a recessionary gap exists.

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