What is Cyclical Unemployment?

Cyclical unemployment is the component of overall unemployment that results from economic upturns and downturns. Unemployment rises during recessions and declines during economic expansions. Moderating cyclical unemployment during recessions is a major motivation behind the study of economics and the goal of the various policy tools that governments employ to stimulate the economy.

Key Takeaways

  • Cyclical unemployment is the contribution of economic recessionary or expansionary conditions to the total unemployment rate.
  • Cyclical unemployment rises during recessions and falls during economic expansions and is a major focus of economic policy.
  • Cyclical unemployment is one factor among many that contribute to total unemployment, including seasonal, structural, frictional, and institutional factors.
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Cyclical Unemployment

Understanding Cyclical Unemployment

Cyclical unemployment relates to the irregular ups and downs, or cyclical trends in growth and production, as measured by the gross domestic product (GDP), that occur within the business cycle. Most business cycles eventually reverse, with the downturn eventually shifting to an upturn again, followed by another downturn.

Economists describe cyclical unemployment as the result of businesses not having enough demand for labor to employ all those who are looking for work at that point within the business cycle. When demand for a product and service declines, there can be a corresponding reduction in supply production to compensate. As the supply levels are reduced, fewer employees are required to meet the lower standard of production volume. Those workers who are no longer needed will be released by the company, resulting in their unemployment

When economic output falls, the business cycle is low and cyclical unemployment will rise. Conversely, when business cycles are at their peak, cyclical unemployment will tend to be low because there is high demand for labor.

Example Cause of Cyclical Unemployment

During the financial crisis in 2008, the housing bubble burst and the Great Recession began. As more and more borrowers failed to meet the debt obligations associated with their homes, and qualifications for new loans become more stringent, the demand for new construction declined. With the overall number of unemployed climbing and more borrowers unable to maintain payments on their homes, additional properties were subject to foreclosure, driving demand for construction even lower. As a result, approximately two million workers in the construction field became unemployed. This rise in unemployment was cyclical unemployment.

As the economy recovered over the following years, the financial sector returned to profitability and began to make more loans. People began buying homes again and remodeling, causing the prices of real estate to climb once again. Construction jobs returned to meet this renewed demand in the housing sector and cyclical unemployment declined.

Classes of Unemployment

Cyclical unemployment is one of the main classes of unemployment as recognized by economists. Other types include structural, frictional, and institutional unemployment. Rather than being caused by the ebbs and flows of the business cycle, structural unemployment is caused by fundamental shifts in the makeup of the economy—for example, jobs lost in the buggy-whip sector once automobiles came to dominate.

It is a mismatch between the supply and demand for certain skills in the labor market. Frictional unemployment is short-term joblessness caused by the actual process of leaving one job to start another, including the time needed to look for a new job. Institutional unemployment consists of the component of unemployment attributable to institutional arrangements such as high minimum wage laws, discriminatory hiring practices, or high rates of unionization.

In most cases, several types of unemployment exist at the same time. With the exception of cyclical unemployment, the other classes can occur even at the peak ranges of business cycles, when the economy is said to be at or near full employment.

Cyclical Versus Seasonal

While cyclical unemployment is attributed to the business cycle of an economy, seasonal unemployment occurs as demands shift from one season to the next. This category can include any workers whose jobs are dependent on a particular season. For example, teachers may be considered seasonal, based on the fact that most schools in the U.S. cease or limit operations during the summer, as well as construction workers living in areas where construction during the winter months is challenging. Certain retail stores hire seasonal workers during the winter holiday season to better manage increased sales, but release those workers during the post-holiday demand shift. Often, official unemployment statistics will be adjusted, or smoothed, to account for seasonal unemployment (called seasonally adjusted unemployment).