The solution for unemployment is, of course, to create new jobs. The number of jobs that need to be created depends on the unemployment rate and the number of people entering the labor force in search of work. When unemployment creeps above 6% to 7% and stays there, it means the economy can't create enough new jobs. That's when the government steps in.
For historical data on U.S. unemployment trends, the Bureau of Labor Statistics publishes the unemployment rate by year. It reports the annual percentage of the unemployed in the labor force, as far back as 1949. It also indicates the success or failure of the fiscal and monetary policies through the years, since they affect the rate of unemployment.
The first solution is expansionary monetary policy from the Federal Reserve. It's powerful, quick, and effective. Lower interest rates make it easier for families to borrow what they need. That includes expensive items like cars, homes, and consumer electronics. It stimulates enough demand to put the economy back on track. Low-interest rates also allow businesses to borrow for less. That gives them the financial capital to hire enough workers to meet rising demand.
If the recession is really severe, then monetary policy might not be enough on its own. That's when fiscal policy is needed. The government can either cut taxes or increase spending to stimulate the economy. An expansionary fiscal policy is slower than monetary policy to get started. It takes time for Congress and the president to agree on the next steps, but it can be more effective once executed. It also provides much-needed confidence that the government will turn things around. Confidence is crucial for convincing people to spend now for a better future.
Cutting taxes works like lowering interest rates. Both give businesses and consumers more money to spend. That increases demand. It gives businesses more cash to invest and hire more workers.
Government spending can also take the form of jobs programs. The government can hire employees directly. It also contracts with companies to build things and provide services. It provides consumers with the cash they need to buy more products.
The Most Cost-Effective Solution
Dollar for dollar, what's the best investment that creates the most jobs? A University of Massachusetts Amherst study found that building mass transit is the most cost-effective solution. One billion dollars spent on public transportation creates 19,795 construction jobs.
Unemployment benefits can provide growth as well. According to Wayne Vroman, an economist and senior fellow at the Urban Institute for the Department of Labor, unemployment insurance led to the creation of 1.6 million jobs on average each quarter from 2008 to 2010. The unemployed are most likely to spend every dime they get. They buy basics like groceries, clothing, and housing. As a result, every dollar spent on unemployment benefits stimulates $1.64 in gross domestic product.
How can $1 create $1.64? It does it through the ripple effect. For example, a dollar spent at the grocery store pays for the food. It also helps pay the clerk's salary, the truckers who haul the food, and even the farmers who grow it. The clerks, truckers, and farmers then buy groceries. This ripple effect keeps demand strong, creating added benefits. Stores keep their employees to supply the goods and services the unemployed need. Without these benefits, demand would drop. Then retailers would need to lay off their workers, increasing unemployment rates.
Unemployment benefits work fast. The government writes a check that goes directly into the economy. Public works projects take longer to get implemented. The plans must be updated, workers hired, and supplies delivered.
Funding education is also an effective unemployment solution. One billion dollars spent hiring teachers adds $1.3 billion to the economy. Better-educated people can get higher-paying jobs. They can buy more things with the higher wages they earn. Each $1 billion spent can create 17,687 jobs. That's much better than defense spending. It only creates 8,555 jobs for the same investment. Defense is more capital-intensive. Modern defense relies more on drones, F-35s, and aircraft carriers than soldiers.
The most popular fiscal stimulus is across-the-board income tax cuts. That's not the most cost-effective, according to the UMass/Amherst study. One billion dollars in cuts creates 10,779 jobs. Workers only spend half the money, which in this case is only $505 million.
As a result, reductions in the tax rate are not the most effective way to help job growth. Most people don't realize they are getting a break until tax time. The tax cut means they pay less in taxes, but they still have to pay. Psychologically, they are less likely to spend anything extra. It just doesn't feel like a bonus. As a result, people are more liable to save anything they get or use it to pay down other debts.
A more effective tax cut is in businesses' payroll taxes. The best place to give business tax relief is with small businesses. From 2000 to 2018, they produced 65% of all net new jobs created.
Fiscal Policy Risks
The downside of fiscal policy is that it could add to the budget deficit. That creates more government debt. As debt approaches 100% of the economy's total output, it slows economic growth. Investors could lose the desire for that government's debt. This makes interest rates rise, increasing the cost of borrowing.
Advocates of supply-side economics say that, over time, tax cuts boost the economy enough to replace any lost tax revenue, but according to the Laffer Curve, that's only true if taxes are over a certain threshold to start with.
The Bottom Line
The government uses two policies to tackle unemployment: monetary and fiscal.
Expansionary monetary policy increases the money supply and:
- Has more immediate effects
- Stimulates demand, production; and ultimately, employment
- Is managed by the Federal Reserve or a central bank
Expansionary fiscal policies include government spending and tax cuts. These:
- Take more time to have an impact
- Have a greater impact on consumerism, so they are more effective as economic stimuli
- Increase government debt and add to the budget deficit
The most cost-effective solutions are fiscal. Building mass transit, granting unemployment benefits, funding the educational sector, and payroll tax cuts allow consumers to gain more income which they spend to spur demand.
Frequently Asked Questions (FAQs)
How does a high unemployment rate affect the economy?
High unemployment can have detrimental effects throughout the economy. When fewer workers are working, it reduces production and GDP. Unemployed workers drain resources from state and federal governments while tax revenues are simultaneously cut. Persistent unemployment can have serious societal effects, as well. A study conducted during the Great Recession showed how extended unemployment can hurt workers' long-term earning potential, which can affect the economy for years to come.
What is the natural rate of unemployment?
The natural rate of employment is an estimate of how low unemployment would go when inflation is stable and economic production is steady. It's difficult to estimate with precision, but economists suggest that it usually hovers around 4.5% to 5.5%. In other words, when the economy is stable and growing neither too quickly nor too slowly, natural unemployment will usually fall somewhere within that range.