Full employment

What Is Full Employment?

Full employment is an economic condition in which all available labor resources are being used in the most efficient way possible, representing the maximum sustainable level of employment an economy can achieve. It is a key concept within macroeconomics, a field that studies the behavior and performance of an economy as a whole. While the term suggests zero unemployment, full employment does not mean that every single person in the labor force is employed. Instead, it accounts for a certain level of unavoidable unemployment, such as individuals transitioning between jobs or those whose skills do not match available positions.

History and Origin

The concept of full employment gained prominence in the mid-20th century, particularly in response to the widespread joblessness experienced during the Great Depression. Before this period, classical economic theory largely held that market economies were self-adjusting systems that naturally tended towards full employment⁴⁴. However, the prolonged mass unemployment of the 1930s challenged this view. John Maynard Keynes, a British economist, revolutionized economic thinking with his 1936 work, "The General Theory of Employment, Interest, and Money"⁴³.

Keynes argued that an economy does not automatically adapt to provide full employment, even in equilibrium, and that volatile market psychology could lead to sustained periods of high unemployment⁴². He introduced the concept that the level of employment is primarily determined by aggregate demand in an economy⁴⁰, ⁴¹. If total demand for goods at full employment is less than total output, the economy would contract. Keynes advocated for government intervention, through fiscal policy and monetary policy, to stimulate demand and achieve full employment³⁹.

In the United States, the post-World War II period saw a significant legislative move towards this goal with the passage of the Employment Act of 1946. This act declared it the continuing policy and responsibility of the federal government "to use all practicable means... to promote maximum employment, production, and purchasing power"³⁶, ³⁷, ³⁸. This foundational legislation laid the groundwork for the Federal Reserve's dual mandate, formalized in amendments to the Federal Reserve Act in 1977, which explicitly directs the central bank to pursue both maximum employment and price stability³¹, ³², ³³, ³⁴, ³⁵.

Key Takeaways

• Full employment signifies the highest sustainable level of employment an economy can achieve, not zero unemployment.
• It accounts for frictional and structural unemployment, which are considered unavoidable.
• The concept was significantly influenced by John Maynard Keynes, who argued that government intervention might be necessary to achieve it.
• In the U.S., full employment is a statutory objective for the Federal Reserve as part of its dual mandate²⁹, ³⁰.
• Achieving full employment typically involves policies aimed at balancing job creation with maintaining stable inflation.

Interpreting Full Employment

Interpreting full employment involves understanding that it is not a fixed number but rather a dynamic concept influenced by various economic factors. Economists often view full employment as the level of employment where there is no cyclical or deficient-demand unemployment²⁸. Cyclical unemployment is joblessness tied directly to downturns in the business cycle or recession. When an economy operates at full employment, the remaining unemployment is primarily due to frictional and structural factors.

Frictional unemployment occurs when workers are temporarily between jobs, actively searching for new employment that better suits their skills or preferences. Structural unemployment arises from a mismatch between the skills of available workers and the skills required for existing job openings, or from geographical disparities between job seekers and available jobs²⁷.

The Federal Reserve, in its pursuit of maximum employment, considers a broad range of labor market indicators beyond just the official unemployment rate. These indicators can include the number of underemployed workers, discouraged workers who have stopped looking for jobs, and measures of how easy or difficult it is for employers to find qualified workers²⁶. The goal is to identify a level of employment that can be sustained without generating excessive inflationary pressures.

Hypothetical Example

Consider a hypothetical country, "Econoville," with a total labor force of 10 million people. Due to regular job transitions (frictional unemployment) and some workers needing retraining for new industries (structural unemployment), economists estimate that even at its healthiest, Econoville will always have about 400,000 people unemployed. This 4% "natural" level of unemployment is considered Econoville's full employment benchmark.

If Econoville's unemployment rate falls to 3.5%, it suggests that the economy is operating beyond its sustainable full employment level, potentially leading to upward pressure on wages and prices as competition for scarce labor increases. Conversely, if the unemployment rate rises to 7%, it indicates a significant amount of cyclical unemployment, meaning the economy is operating below its full employment potential, often a sign of a looming or ongoing recession. In such a scenario, policymakers might consider stimulating economic growth to move towards full employment.

Practical Applications

Full employment is a central objective for central banks and governments in shaping macroeconomic policy. In the United States, the Federal Reserve's primary objectives, known as its "dual mandate," are to promote maximum employment and price stability²⁴, ²⁵. This means that the Federal Open Market Committee (FOMC) considers the state of employment when making decisions about interest rates and other tools of monetary policy²³. When unemployment is high, the Fed might pursue expansionary policies to stimulate job growth, while extremely low unemployment could lead to concerns about rising inflation, prompting tighter monetary policy.

Governments also use fiscal policy, such as government spending and taxation, to influence aggregate demand and support full employment²². For example, during periods of economic slowdown, increased government spending on infrastructure projects or unemployment benefits can help create jobs and boost economic activity. The Bureau of Labor Statistics (BLS) plays a crucial role by collecting, analyzing, and publishing data on the U.S. labor market, including various measures of unemployment, which policymakers use to assess progress toward full employment²¹. The official unemployment rate (U-3) is a widely watched indicator, but the BLS also provides broader measures of labor underutilization (U-4, U-5, U-6) for a more comprehensive view of the labor market health¹⁹, ²⁰.

Limitations and Criticisms

Despite its importance as a policy goal, the concept of full employment faces several limitations and criticisms. One challenge is that full employment is not directly observable and must be estimated, leading to varying interpretations and debates among economists¹⁷, ¹⁸. Historically, the "full employment" unemployment rate has been a moving target, with estimates fluctuating over time.

A major criticism emerged in the late 1960s with the work of economists Milton Friedman and Edmund Phelps, who introduced the concept of the "natural rate of unemployment" (also known as the Non-Accelerating Inflation Rate of Unemployment, or NAIRU)¹⁶. They argued that there is an unemployment rate below which inflation will continuously accelerate¹⁵. Attempting to push unemployment below this natural rate through demand-side policies would only lead to higher inflation in the long run, without a lasting reduction in joblessness¹⁴. This suggests a trade-off between unemployment and inflation, implying that true full employment—where every willing and able person has a job without causing accelerating prices—may not be achievable through traditional aggregate demand stimulus alone. Re¹³search by the International Monetary Fund (IMF) has also explored methods for jointly estimating the natural rate of unemployment and potential output, acknowledging the intricate relationship between labor market conditions and price pressures.

A¹¹, ¹²nother limitation is that official unemployment statistics, such as those provided by the Bureau of Labor Statistics, may not fully capture all forms of underemployment or individuals who have become discouraged and stopped looking for work. Th¹⁰is can lead to an underestimation of the true extent of labor market slack, even when the reported unemployment rate is low.

Full Employment vs. Natural Rate of Unemployment

While closely related, full employment and the natural rate of unemployment are distinct concepts within economics.

Full employment is a broad policy objective and an ideal state where an economy maximizes its utilization of human capital. It implies that all available workers who desire employment at prevailing wage rates can find jobs, with unemployment limited to frictional and structural forms. It represents the absence of cyclical or demand-deficient unemployment.

The natural rate of unemployment (also known as NAIRU) is a specific theoretical concept representing the lowest unemployment rate that an economy can sustain without causing an acceleration of inflation. It⁸, ⁹ is the rate of unemployment that exists when the labor market is in equilibrium, with wages and prices adjusting to their long-run levels. Th⁷e natural rate incorporates frictional and structural unemployment but excludes cyclical unemployment. In essence, when an economy is at its natural rate of unemployment, it is considered to be at full employment, as any attempts to push unemployment lower through stimulative policies are believed to lead only to higher inflation, not sustained job creation.

T⁶he key distinction lies in their nature: full employment is a policy goal and a state of optimal resource utilization, while the natural rate of unemployment is a theoretical construct that attempts to define the specific unemployment rate consistent with non-accelerating inflation, thus often serving as a practical benchmark for what constitutes full employment for policymakers.

FAQs

What types of unemployment exist even at full employment?

Even at full employment, two types of unemployment persist: frictional unemployment, which occurs when people are temporarily between jobs or searching for new ones, and structural unemployment, which results from a mismatch between the skills of job seekers and the requirements of available jobs, or from geographical location issues.

#⁵## Why is 0% unemployment not considered full employment?
A 0% unemployment rate is unrealistic and undesirable because a healthy labor market naturally involves some level of job searching and transitions. People will always be entering and exiting the labor force, changing careers, or relocating, which contributes to frictional unemployment. Furthermore, technological advancements and shifts in industries can lead to structural unemployment, requiring workers to retrain or relocate. Attempting to achieve 0% unemployment could lead to severe inflation as businesses desperately compete for an extremely limited pool of workers.

How does the Federal Reserve aim for full employment?

The Federal Reserve, as part of its dual mandate, aims for "maximum sustainable employment" alongside price stability. It³, ⁴ uses monetary policy tools, such as adjusting interest rates, to influence aggregate demand and encourage job creation. When the economy is weak and unemployment is high, the Fed may lower interest rates to stimulate borrowing and spending, which can boost economic activity and employment. Conversely, if employment is too strong and inflation is a concern, the Fed might raise rates to cool down the economy.

#²## What is the relationship between full employment and inflation?
Economists generally acknowledge a complex relationship between full employment and inflation, often described by the Phillips Curve. In the short run, it's believed that lower unemployment might lead to higher inflation, as a tight labor market can lead to upward pressure on wages and, subsequently, prices. However, many economists believe that in the long run, there is no permanent trade-off, and trying to maintain unemployment below its "natural rate" will only result in accelerating inflation without achieving a permanently lower unemployment rate.
¹