What is lag?
A lag in the field of economics refers to an event in the economy that persists even after the factors that caused it have been removed or otherwise operated. Lag typically occurs after extreme or long-term economic events, such as an economic crash or recession. For example, after a recession, unemployment may continue to rise even though the recession in economic growth and technology has ended.
- A lag in economics refers to an event in the economy that persists into the future, even after the factors that caused the event have been eliminated.
- The lag can include the delayed effect of unemployment, which continues to rise even after the economy recovers.
- The lag could indicate a permanent shift in the workforce due to loss of job skills, making workers less employable even after the recession ends.
The term hysteresis was coined by Scottish physicist and engineer Sir James Alfred Ewing (1855-1935) to refer to systems, organisms and domains with memory. In other words, the results of some inputs appear with a certain time lag or delay. Take iron as an example: iron retains a certain magnetization after being exposed to or removed from a magnetic field.Hysteresis is derived from the Greek word meaning shortage or insufficiency.
Economic lag occurs when a single disturbance affects the economic process. The exact cause of the hysteresis varies with the triggering event. Having said that, technically speaking, the most common reason for a sustained market downturn after an event has passed is a change in the attitude of market participants due to the event. For example, after the market crashed, many investors were reluctant to reinvest their cash on hand due to recent losses. This reluctance translates into a prolonged period of share price downturn due to investor attitudes rather than market fundamentals.
Unemployment rate lags
A common example of lag is the delayed effect of unemployment, which may continue to rise even as the economy begins to recover. The current unemployment rate is the percentage of people in an economy who are looking for work but cannot find it. To understand the hysteresis of unemployment, we must first explore the types of unemployment. Unemployment rose in a recession that has contracted growth for two consecutive quarters.
When a recession occurs, cyclical unemployment rises as the economy experiences negative growth rates. Cyclical unemployment rises when the economy is underperforming and falls when the economy expands.
Natural unemployment is not the result of a recession. Rather, it is the result of the natural movement of workers. Natural unemployment explains why the unemployed exist in a growing, expansionary economy. Also known as the natural rate of unemployment, the natural rate of unemployment represents people, including college graduates or those laid off by technological advances. The continuous flow of labor in and out of employment constitutes natural unemployment. However, natural unemployment can arise from voluntary and involuntary factors.
Structural unemployment occurs when workers are laid off as factories relocate or technology replaces their jobs. Structural unemployment is part of natural unemployment that occurs even in healthy and expanding economies. This may be due to changing business conditions or economic conditions and may continue for many years. Structural unemployment is often the result of business changes, such as factories relocating overseas, technological changes, and a lack of skills for new jobs.
Why there is a lag in unemployment
As mentioned earlier, cyclical unemployment is caused by a downturn in the business cycle. Workers lose their jobs when businesses lay off workers during periods of sluggish demand and declining business income. When the economy re-enters the expansion phase, businesses are expected to start rehiring the unemployed and the economy’s unemployment rate will begin to decline toward the normal or natural rate until the cyclical unemployment rate is zero. Of course, this is the ideal situation. However, the lag tells a different story.
The lag suggests that as unemployment increases, more people adjust to a lower standard of living. When they get used to a lower standard of living, people may not be motivated to achieve the higher standard of living they previously expected. Also, as more and more people lose their jobs, it becomes more socially acceptable to be unemployed or remain unemployed. After the labor market returns to normal, some of the unemployed may not be interested in returning to the labor market. Finally, and most importantly, employers themselves have been through a lot of pain during the downturn and are more likely to ask for more surplus workers before incurring the greater cost of adding labor.
Lag caused by technology
Unemployment lags can also be observed when businesses turn to automation during market downturns. When the economy begins to recover, workers without the skills needed to operate such machines or newly installed technology will find themselves out of work. In addition to hiring only tech-savvy workers, these companies will end up hiring fewer people than they did before the recession phase. In effect, the loss of job skills will cause workers to move from a cyclical unemployment phase to a structurally unemployed group. A rise in the structural unemployment rate will lead to an increase in the natural rate of unemployment.
The lag could indicate a permanent shift in the workforce due to loss of job skills, making workers less employable even after the recession ends.
The recession that the UK experienced in 1981 is a good illustration of the lag effect. During the country’s recession, unemployment rose sharply from 1.5 million in 1980 to 2 million in 1981. After the recession, the unemployment rate rose to more than 3 million between 1984 and 1986.The turmoil of the recession created structural unemployment that persisted and became unmanageable during the recovery.
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How to prevent lag
Economies that are experiencing recessions and lagging, in which the natural unemployment rate is rising, typically resort to economic stimulus to counter the resulting cyclical unemployment. Expansionary monetary policy by central banks such as the Federal Reserve can include lowering interest rates to reduce the cost of borrowing and help stimulate the economy. Expansionary fiscal policy may also include increased government spending in areas or industries most affected by job losses.
However, the lag isn’t just about cyclical unemployment, it’s likely to persist long after the economy recovers. For long-term problems, such as a lack of skills among workers due to technological advances, vocational training programs may help eliminate lag.