1. News & Issues
About.com
US Economy

Discuss in my forum

Cyclical Unemployment

By , About.com Guide

cyclical unemployment

Construction is usually the first industry to get hit with cyclical unemployment.

Photo: Justin Sullivan/Getty Images)

Cyclical Unemployment Definition:

Cyclical unemployment is when workers lose their jobs during downturns in the business cycle. It generally happens when the economy contracts, as measured by Gross Domestic Product (GDP). If the economy contracts for two quarters or more, then the economy is in a recession.

Cyclical unemployment is usually the cause of high unemployment, when rates quickly grow to 8% or even 10% of the labor force. It's known as cyclical because, when the economy re-enters the expansion phase of the business cycle, the unemployed will get rehired. Cyclical unemployment is temporary -- although it could last anywhere from 18 months (the typical time frame of a recession) to ten years (during a depression).

Causes of Cyclical Unemployment:

Cyclical unemployment results from a large drop-off of demand. It usually starts with less personal consumption. When consumer demand for goods and services drops, business revenues decline, and eventually companies have to lay off workers to maintain profit margins. Often there isn't enough production to keep the workers busy.

The last thing a business wants to do is layoff workers. It's a traumatic event, and a company could lose valuable employees that it's invested a lot in. That's why, by the time cyclical unemployment starts to climb, the economy is usually already in a recession. Businesses wait until they're sure the downturn is severe before starting layoffs.

What can kick off the economic downturn that results in cyclical unemployment? Often, it's a stock market crash, such as the crash of 1929, the tech crash of 2000, and the financial crash of 2008. A bad crash can cause a recession by creating panic, and subsequent loss of confidence in the economy. Businesses suffer a loss of their net worth as stock prices plummet. Even before demand in the general economy falls, they can lose their ability to raise capital to grow and expand.

As stock market wealth evaporates, consumers delay purchases, waiting to see if confidence returns. If it does, as happened in the 1987 stock market crash, then economic growth resumes and cyclical unemployment doesn't get started. However, if confidence continues to erode, lowered demand forces businesses to lay off workers, resulting in cyclical unemployment.

Effects of Cyclical Unemployment:

Unfortunately, cyclical unemployment can become a self-fulfilling, downward spiral. That's because the newly unemployed now have less disposable income to spend. This further lowers demand and business revenue, leading to even more layoffs. Without intervention, this spiral will continue until supply has dropped to meet the lowered demand. Unfortunately, this may not happen until unemployment reaches 25%, as happened during the Great Depression. It could also take a decade, as the Depression did. In fact, the only thing that truly ended the Depression was demand for military equipment production as the U.S. entered World War II. This massive fiscal spending resulted in an increase in the U.S. debt.

Cyclical Unemployment Examples:

An example of cyclical unemployment is the loss of construction jobs during the 2008 financial crisis. As the housing crisis unfolded, home builders stopped constructing new homes. As many as 2 million construction workers lost their jobs. Whenever home building starts up again, they will be able to go back to work. (Source: CBS News, 2 Million Construction Jobs Lost, June 16, 2011)

Someone can start out being cyclically unemployed, and wind up being being a victim of structural unemployment. During the recession, many factories switched to robots and sophisticated computer equipment to run machinery. Workers now need to get updated computer skills so they can manage the robots that now runs the machinery they used to work on themselves. Unfortunately, fewer workers are needed. Those that don't go back to school are structurally unemployed. That's because their skills no longer match the needs of the workforce.

Cyclical Unemployment Rate:

The cyclical unemployment rate is the difference between the natural unemployment rate and the current rate. The natural rate includes structural, frictional, and surplus unemployment. Subtract those from the unemployed and the labor force and, Voila!, you have the cyclical unemployment rate. In real life, it's difficult to look at the data and determine why each person is unemployed. Therefore, economists have come up with two other methods to estimate how much of unemployment is cyclical.

The first, and most common, method is to take the unemployment rate during the peak phase of the business cycle, subtract it from the unemployment rate during the trough phase, and chalk the rest up to cyclical unemployment.

The second is to compare the unemployment rate for recent college graduates with the unemployment rate overall. If their rate is similar to the overall rate, then most of the nation's unemployment is cyclical. Why? Recent college graduates have new skills, and are able to move to wherever the jobs are. Therefore, they have very little of the reasons for structural unemployment. Using this method, researchers found that the most of the unemployment in 2011 was cyclical. (Source: Bureau of Labor Statistics, Current unemployment:cyclical or structural?, March 21, 2011)

Cyclical Unemployment Solution:

Because cyclical unemployment can so quickly spiral out of control, usually the Federal government must step in to stop it. The first, and easiest, response is with expansionary monetary policy. The Federal Reserve will start lowering interest rates. This is like putting money into the pockets of families and businesses. That's because it lowers all interest rates, making loans and even credit card payments cheaper. Furthermore, just knowing that the Fed is taking action may restore the confidence needed to boost demand.

If that's not enough, then expansionary fiscal policy must be used. This takes longer, because usually the President and Congress must vote on more spending. This raises the budget deficit. It also re-ignites the bi-partisan debate as to whether tax cuts or spending are more effective job creators. However, a U Mass/Amherst study shows that the most cost effective unemployment solution is spending on public works projects to create construction jobs. This makes sense, since these jobs are the most cyclical. The second is extending unemployment benefits. Tax cuts, according to the research, is less effective in creating the demand needed to stop cyclical unemployment. Article updated June 9, 2012

©2013 About.com. All rights reserved.