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What is Cyclical Unemployment?

Last updated 03/20/2024 by

Benjamin Locke

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Cyclical unemployment is unemployment that is directly correlated to upswings and downswings in the business cycle. During a recession, unemployment tends to trend upwards, whereas in an expansionary period of economic growth, unemployment trends downwards. Many of today’s policy tools and government-utilized economic theory during a recession focus on how to mitigate a rise in unemployment.
In modern economics, economies are usually defined by cycles that either expand or contract. One of the key factors in measuring the health, trajectory, and effects of an expanding or contracting economy is understanding the cyclical unemployment rate. Cyclical unemployment occurs when the economy is following one of these trajectories.
Economies typically behave in cycles of growth (expand) and recession (contract). Cyclical unemployment is the correlation between the unemployment rate and the state of the business cycle. For example, if a country is expanding and experiencing high GDP growth, unemployment should be trending downwards. In contrast, if an economy is shrinking or in a recession, the unemployment rate trends upwards. In downcycles, the goal of any country’s economic policy is to stimulate growth and lessen unemployment.

What causes downcycle cyclical unemployment?

Cyclical unemployment is a normal part of any recession. Consumer demand for goods falls, which causes jobs related to the service and production of those goods to fall. This leads to jobs being cut, which then affects the spending ability of those who become unemployed.
This is a natural part of the business cycle. As we mentioned briefly above, the business cycle is full of expansions and peaks before hitting periods of contraction and troughs.
Example of business cycle showing the contraction, trough, expansion, and peak of a business
During a time of high economic activity (expanding towards a peak), business revenue increases and so does the size of the company’s labor force. When the economy is headed towards a trough, businesses see a decrease in revenue, and unemployment rises.

Example of cyclical unemployment

For example, let’s say that something occurred, such as the 2008 financial crisis or the dot com bubble, which contributed to a recession in the early 2000s. Perhaps you worked in the tech industry and were fired from your job in the early 2000s. Every week you would buy an Awesome Blossom for lunch at a local Chili’s down the street.
Now that you have no income, you decide to cut the Friday onion flower out of your routine. If you are having trouble paying for this delectable treat, then so are others. Due to the lack of Awesome Blossom sales, Chili’s experiences a lack of incoming cash flow. This means that in order to survive, Chili’s needs to shed jobs. The people who lost their jobs will not have the spending power to buy their usual goods, and so on. Thus, you can see the knock-on effect of a cyclical downturn and how that results in downward cyclical unemployment.

The housing market crash

Another example of cyclical unemployment occurred in 2008 when the housing bubble burst. Since fewer and fewer people could make their mortgage payments during this time, demand for construction fell significantly. When financial institutions foreclosed on thousands of homes because of unpaid debts, the demand for new construction fell even further.
This low demand resulted in millions of construction workers losing their jobs through cyclical unemployment. It wasn’t until the following years, when the recession began to end and more people could afford home loans, that demand for new construction rose and cyclical unemployment lowered.

Cyclical unemployment rate and GDP growth

GDP growth is fundamentally attached to the cyclical unemployment rate. If the GDP is falling, unemployment rates will rise in turn. If the GDP is expanding, the unemployment rate will fall. The relationship can be expressed by referencing the graph below.
As you can see, the GDP reduction rate substantially corresponds to the reduction in the unemployment rate. If a country’s GDP is forecasted to go one way or another, you can determine what the future employment situation will look like.

Cyclical unemployment and Keynesian economics

Keynesian economics was developed by John Maynard Keynes in the early 20th century. It was one of the major tools used in ending the Great Depression, although this is debated. The philosophy revolves around the idea that increasing demand on an aggregate scale is the most important facet when looking at turning around an economy.
As governments understand the business cycle and the aggregate effects of a downturn, their main goal is to mitigate the unemployment increase that will be tied to any sort of downturn. This means that they will attempt to use government policy to help shorten the recession and get people back to work. The utilization of Keynesian economic theory, to help shorten and lessen the effects of a downturn, is among the most widely used by governments around the world. This has been the weapon of choice to combat cyclical unemployment.

Lower interest rates

By lowering interest rates, you are encouraging people or companies to borrow cheaply and spend or invest the funds. By doing this, you are injecting money back into the economy to increase demand.

Fiscal stimulus

Governments will inject money into an economy to stimulate it in the name of growth, and to counteract downward cyclical trends. When a government invests money in, say, infrastructure, this will automatically create jobs for people building said infrastructure.
This keeps more people employed and thus more money in their pockets. In turn, the money in their pockets contributes to more demand for goods.

Different unemployment types

Cyclical unemployment is just one of the types of unemployment that we measure in economics. To understand the bigger picture, we can also look at crucial economic variants of unemployment.

Structural unemployment

Structural unemployment is caused by fundamental changes that might reorganize an economy. Typically, this happens when people lack the skills to deal with changes in technology.
For instance, back when people drove horse carriages around, there were many jobs related to horses and carriage maintenance. After the invention of the automobile, those people’s skills were no longer needed. Thus, they are victims of structural unemployment.

Seasonal unemployment

Seasonal unemployment is related to a change in season that might affect an industry. The ski industry in North America is a great example.
The mountains of Colorado are packed with employees from all around both the country and the globe. When the season turns to spring and summer, many of those jobs are no longer required. In that case, unemployment typically rises in this industry.

Frictional unemployment

Frictional unemployment is the inevitable period of unemployment that people experience when they are transitioning from one job to another. This can be considered a good trend because it means people are probably transitioning to better jobs.

Institutional unemployment

Institutional unemployment is caused by a third party or institution, including some governments. If, for example, the government of the Dominican Republic was to force the cultivation of bananas, everyone in the banana industry would become unemployed.
Labor unions can also have a profound effect on institutional unemployment. If a labor union insists that workers in a particular industry go on strike, this can result in widespread institutional unemployment.

Key Takeaways

  • Cyclical unemployment is the unemployment rate that correlates to the upward or downward trajectory of an economy.
  • In an economic recession, aggregate demand will fall and thus cause the labor market to fall, which will cause unemployment to go up. Alternatively, when coming out of a recession, demand increases and leads the labor market to rise, causing the unemployment rate to dip.
  • Cyclical unemployment is directly related to GDP growth. When GDP growth increases, cyclical unemployment should fall. When GDP falls, cyclical unemployment should increase.
  • Governments’ and policymakers’ goals are supposed to mitigate the downside factors of a recession and cyclical unemployment.
  • Cyclical unemployment is just one type of unemployment among many.

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