December 29, 2009
How Important Is Structural Unemployment in the Current Recession/Recovery?
Joseph Lawler at the Spectator distills the Austrian perspective on the sources of current unemployment.
Economists of a statist or Keynesian bent tend to posit that modern managers are quicker to fire employees and squeeze extra productivity out of their remaining workers, and then explore why that might be so. ...
There is a more compelling, more market-based explanation that borrows insights from Austrian-style economists like Joseph Schumpeter and Chicago business cycle theorists like Fischer Black. It focuses on the changes that the modern labor market has undergone, and explores the possibility that recessions now cause structural, as opposed to cyclical, changes in hiring. Cyclical changes are responses to the business cycle: companies across all industries tighten their belts and start laying off employees when austerity threatens, but then rehire the workers they laid off when good times roll again.
A structural change in the labor market, on the other hand, occurs when hiring patterns change not as a function of economic fluctuations, but because of shifts in the economy's production that reallocate workers among industries. In other words, a mismatch between what consumers demand and what producers are making necessitates a shake-up in the mix of industries. Perhaps the most familiar example of a structural change is the Industrial Revolution, when, starting in the 18th century, Great Britain's labor force transitioned from manual labor to machine-aided manufacturing jobs in great numbers.
I've been teaching intermediate macroeconomics for some twenty years. While it's true that a distinction has typically been made between frictional, structural and cyclical unemployment in the textbooks, since at least the hysteresis literature of the 1980's, there's been an understanding that aggregate demand shocks can induce long lasting and persistent unemployment. Hence, the distinction between the mainstream view (as taught in advanced macro textbooks) and this Austrian view is, I think, a bit overdrawn.
But Mr. Lawler's assertion did impel me to take a look at the data, to see at a gross level how big the structural changes might be in the two examples cited in the article, namely construction and manufacturing. Here's a breakdown of total payroll employment change relative to NBER defined peak (blue), as well as construction (red) and manufacturing (green).
Figure 1: Change in employment, in 000's, relative to NBER defined peak. NBER defined recession dates shaded gray. Source: BLS November 2009 release, via FRED II, and NBER.
There was a big change particularly in manufacturing, suggestive of big structural shifts. Interestingly, these data are for the 1981-1982 recession, the last big recession before the last two "jobless recoveries". Below is the analogous graph for the current recession.
Figure 2: Change in employment, in 000s, relative to NBER defined peak. NBER defined recession dates shaded gray, assuming trough at 2009M06. Source: BLS November 2009 release, via FRED II, and NBER.
(Note the change of scales.) This argument is explicitly not to deny that structural shifts are important (part of the decline in potential growth that is likely to occur will be due to these mismatches, as I've discussed before ). But I do wonder about the assertion that the structural shift is the major component of the unemployment currently observed (Valletta and Cleary (2009) provide a skeptical look). Is there a stylized fact that indeed "...modern technologically advanced firms do a better job calculating their optimal amount of labor without resorting to temporary layoffs -- if they downsize, they downsize permanently because their industry is shrinking."? Something like this phenomenon should show up in the micro firm-level data, I would suppose as higher volatility. As Davis and Kahn note in their survey of the Great Moderation, the data are not supportive of this conjecture.
Another interesting assertion that Mr. Lawler makes in support of the re-allocation thesis is that Okun's law fails to predict the current level of unemployment. In Figure 3, I show the output gap and unemployment rate, and in Figure 4, the implied unemployment rate using the regressions estimated over the 1967-09 and 1967-88 periods. (Of course, there are different Okun's laws, including those using payroll employment, and in first differences, as I noted in this post).
Figure 3: Output gap in log terms (red, left scale) and unemployment rate, quarterly average of monthly data (blue, right scale). NBER defined recession dates shaded gray, assumes last recession ended 09Q2. Source: BEA, 09Q3 3rd release, CBO January 2009 estimate of potential, rescaled by 1.14 to convert to Ch.2005$, BLS via FRED II, NBER.
Figure 4: Actual unemployment rate (blue), and fitted values using 1967-09 regression (red) and using 1988-2009 (green). Source: BLS via FRED II, NBER, and author's calculations.
What I find interesting is that if one uses the last two decades to estimate Okun's law (in levels), one does find underprediction by about a percentage point, and indeed the actual outcome for 2009Q3 is statistically significantly different from the predicted value. However, if one uses the entire 1967-09 sample (which is consistent with the view that the current recession is due to a mixture of deficient aggregate demand and changes to the composition of demand), then the misprediction is minimal in both economic (a third of a percentage point) and statistical terms.
To summarize: secular structural unemployment is likely to have risen. But it is not clear to me that an increase in structural unemployment constitutes the largest portion of the increase in unemployment. If a large negative aggregate demand shock explains a large portion of the negative output gap, then the Okun's law coefficient over a longer sample may be more relevant. This conclusion does not deny the fact that unemployment rates may remain elevated, since the output gap is likely to be negative for an extended period of time. The big difference is with respect to policy prescriptions. The Lawler interpretation suggests macrostabilization policy (read monetary and fiscal policy) is worse than useless. A different interpretation, ascribing substantial import to deficient aggregate demand, suggests that monetary and fiscal policies in support of aggregate economic activity is a useful endeavor.
Update: 7:10pm Pacific
Reader ts requests residential construction, and FIRE, broken out in Figure 2. These additions make no material difference to the basic message in Figure 2.
Figure 5: Change in employment, in 000s, relative to NBER defined peak. NBER defined recession dates shaded gray, assuming trough at 2009M06. Source: BLS November 2009 release, via FRED II, and NBER.
Posted by Menzie Chinn at December 29, 2009 11:01 AMdigg this | reddit
So much of what went before was mortgage equity extraction, it is difficult to see how that loss of demand can be made up quickly, but what was structural was how it originated, not how it was spent. Without an engine, coasting along is about all we can do.
Posted by: Lord at December 29, 2009 01:25 PM
If you want to take an aggregate view then it might be more useful to look at job creation and job destruction couched within a vacancy/unemployment framework. Then look inside the firm at expected discounted cost per new hire relative to expected discounted value product of each hire. The v/u and new hire rates should remain historically low until uncertainty surrounding expected cost per new hire is resolved. Congress needs to move one way or another on health care and carbon legislation so that firms know how much it will cost to add a worker. In addition, there exists the possibility that additional taxes per worker will be necessary to pay for social security, medicare and growing governemnt budget deficits.
At the same time, a tight credit environment that retards investment in plant and equipment will reduce expected discounted marginal value product of a new hire.
A likely result is a stagnant labor market with firms replacing job leavers and perhpas recalling some prior layoffs, but not much in the way of sustainable growth in employment.
Posted by: tj at December 29, 2009 02:34 PM
Very interesting post. I do have some issues with the analysis, however.
First, you should have looked at residential construction employment rather than construction employment in general. Non-residential construction employment is on a different cycle (CRE has only recently collapsed, civil construction has actually increased due to the effects of the stimulus bill).
In addition, the cycle is not concurrent with the GDP cycle. Residential real estate was starting to falter well before the official NBER recession. The peak in residential building employment was April 2006 (according to BLS) at 1022.5 thousand employees (SA). The current level of this series is 675.5 thousand, a contraction of roughly 35%! Residential specialty trade contractors show a similar cycle, peaking at 2439.7 thousand employees in February 2006 and currently employing 1683.0 thousand, a contraction of roughly 30%.
Another suggestion would be to provide perspective on the relative percentage changes of these series, as well as the overall size of the series. Construction is only 8%-10% of total employment, so even large absolute changes will seem insignificant compared to absolute changes in total employment. This problem is magnified when residential construction is only about 15-20% of construction employment and RSTCs are 30-35%.
You could have expanded the analysis a lot more by including industries such as FIRE (all four letters in the acronym are real estate related) and the different service industries that also work in tandem with the housing industry (e.g. title search companies are in information services 519190).
But in general, I think your graph on Okun's law illustrates a lot. Up until 1995 or so, the general consensus was that 6% unemployment was the NAIRU and yet we spent the latter half of the 1990s and a good chunk of the early 2000s well below those levels. This period was in conjunction with the largest amounts of home equity extraction and declines in savings rates. If you view (as I do) the current de-leveraging process as structural, an argument could be made that about 2-3% of unemployment is now structural because we cannot maintain the household consumption rates of the boom/bubble years. This would necessarily show up in all industries and muddle any comparative analysis.
Posted by: ts at December 29, 2009 06:36 PM
tj: This point regarding vacancies/unemployment rate is discussed in the linked-to Valletta-Cleary piece.
ts: See Figure 5 I've added. I do not think you will arrive at a different conclusion from what you obtained from Figure 2.
Posted by: Menzie Chinn at December 29, 2009 07:18 PM
It will be interesting to revisit this analysis a few years down the road. Presently, the Fed's 'quantitative easing' is masking/preventing unemployment that would be occuring if we had market interest rates.
The demand for cars, homes, & other goods which people buy with borrowed money was artificially stimulated by Greenspan's 1% rate. Firms therefore over-expanded capacity to make the wrong goods. Bernanke's 0% rate temporarily shields us from the truth of how far demand for these goods can fall.
Posted by: bryce at December 29, 2009 07:42 PM
Off topic but related to Bryce's comment above, could someone please explain to me how the Fed 'controls' interest rates. I understand that they implement a target fEd funds rate through open market operations, the have begun quanitative easing to affect the longer end of the curve, and they have the ability to create money through the reserve requirement and the money multiplier process. All of this is very influential on rates, but still does not account for inflation expectations or credit risk premiums. Suppose inflation expectations went from zero to 3%, and the fed left short term rates at zero, how would this affect 1 year treasury rates?
Posted by: Anom at December 30, 2009 05:31 AM
Professor Chinn, nice post. Just for the sake of clarity, what form does your regression specification of Okun's law take? do you address any of the Plosser and Schwert criticisms by incorporating the participation rate or a term to account for non-stationarity in the variables?
Posted by: RF at December 30, 2009 06:18 AM
This is indicative of how two people can look at the same graph and reach totally different conclusions.
If the decline in non-manufacturing (i.e. services) employment is not structural, then what, precisely, is it? Cyclical? We have never had cyclical job loss behavior in services employment. Is this the beginning of a new type of business cycle? If so, what is the driver of cyclical services job loss? In manufacturing, it was clearly inventories, and, for deeper recessions, capital investment. Services?
It is much more likely that this first-ever services recession is structural. We built up too much discretionary spending on services during the period where both services and consumer spending rose as a percentage of GDP. Think just of your average strip mall, and all the mortgage brokers, massage therapists, hair colorists, waiters and others. These are primarily small businesses (which also fits with current data), and they are suffering. My thesis is that, as consumer spending falls as a percentage of GDP, these jobs are not likely to return.
In any case, its utterly surprising that an economist can look at a graph like the 2008-2009 one that you posted above, and not ask a dozen questions about what, exactly, is going here.
Posted by: David Pearson at December 30, 2009 06:46 AM
I think the chart that shows long term unemployed(over 6 months) should be added to this post. I believe currently that figure is two to three times higher than in the early 80's when UE was actually higher than now.
Posted by: Mark G. at December 30, 2009 07:13 AM
Posted by: W.C. Varones at December 30, 2009 07:52 AM
RE: The specification is extremely simple, for the sake of transparency:
ue[t] = α  + α  gap[t] + u [t]
A simple Engle-Granger type test indicates stationarity over the full sample. A Johansen cointegration test rejects the no-cointegration null at 5% using asymptotic critical values (4 lags of first differences, allows deterministic trend in data).
David Pearson: Indeed, there are many questions raised by these graphs, and I hope to look further into them in another post, when I've had some time to consult further with the experts. In the meantime, I look forward to your quantitative analyses of these data (which are available for you to download at FRED and BLS).
While it is true is the current losses in services are substantially greater than in previous recessions, your assertion that there has never been any cyclical job loss in services is falsified by quick examination of FRED series SRVPRD.
Posted by: Menzie Chinn at December 30, 2009 08:26 AM
Bianco Research has published data on service sector employment loss as a percentage of the total during recessions dating back to the 70's. In the '73 and '81 recessions, it was roughly 4%. In the '91, a bit higher. In 2001, the number was roughly 15%. This time around, you can check your own chart and see its over 50%. Services may have shown cyclical behavior in the past, but that is not the question. The question is whether the current employment loss is structural (I prefer secular) or cyclical. The manifestly different behavior of services employment this time around suggests that either services has entered into a new period of more deeply cyclical behavior, or it is undergoing a structural change. The duration of unemployment over 26wks, which is at record and still climbing, supports this conclusion.
Sure, there are benefits to looking at the data in a more granular fashion. But to suggest that this job loss experience is not structural because it did not occur in manufacturing -- as if that could be the only sector undergoing structural change -- is to gloss over the main questions posed by the high-level data.
Posted by: David Pearson at December 30, 2009 08:38 AM
In light of the Fed's programs, I saw yesterday that Eric Sprott is betting on another significant downturn in the markets because of all the government intervention and consequences of their policies: http://www.businessweek.com/news/2009-12-29/sprott-says-s-p-500-to-tumble-below-its-march-low-update2-.html
there's also some interesting stories on his firm's site on these topics: http://www.sprott.com/PreciousMetals.aspx?id=53
Posted by: strainer at December 30, 2009 08:57 AM
Thank you very much Professor Chinn. one quick question, what output-gap measure you used in the following regresison ue[t] = α  + α  gap[t] + u [t]
Posted by: BC at December 30, 2009 08:57 AM
Unemployment, both in the U.S. and the world as a whole, marches ever higher because the field of economics doesn't account for the relationship between population density and per capita consumption.
Following the beating the field of economics took over the seeming failure of Malthus' theory, economists adamantly refuse to ever again consider the effects of population growth. If they did, they might come to understand that once an optimum population density is breached, further over-crowding begins to erode per capita consumption and, consequently, per capita employment.
And these effects of an excessive population density are actually imported when a nation like the U.S. attempts to trade freely with other nations much more densely populated - nations like China, Japan, Germany, Korea and a host of others. The result is an automatic trade deficit and loss of jobs - tantamount to economic suicide.
Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!
If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at http://PeteMurphy.wordpress.com.
Author, "Five Short Blasts"
Posted by: Pete Murphy at December 30, 2009 09:19 AM
If there are in fact structural changes in the economy that require a shift in labor from one industry to another, could government reduce the period of high unemployment by actions that help the shift occur more rapidly?
Posted by: DS at December 30, 2009 09:57 AM
David Pearson: Sorry, I took your statement:
We have never had cyclical job loss behavior in services employment.
at face value.
In any case, I agree it's an open question, although service workers might be more substitutable across industries than say construction. See this this recent Chicago Fed article.
BC: See notes to Figure 3; it's log of ratio of GDP to CBO potential.
Posted by: Menzie Chinn at December 30, 2009 12:08 PM
What's ironic is that you use the charts above to argue that stimulus policies just may be effective. Any policy maker or political observer reading your post could use it to buttress that argument. And obviously that would be wrong. Its just as likely, looking at the data, that the service sector is undergoing a never-before-seen structural adjustment, one which would be resistant to stimulus.
The further irony of your post is that we may have reached a trough in the decades-long structural adjustment in manufacturing as a share of gdp. If the U.S. is to reduce its current account surplus, increase its savings rate, reduce real wages -- all adjustments that economists both expect and prescribe -- then its entirely likely that the manufacturing share of the economy will be greater five years from now than today. Certainly Ben Bernanke -- the architect of the current weak dollar policy -- would hold that expectation.
Posted by: David Pearson at December 30, 2009 04:06 PM
In my humble opinion three important facts stand out in the determination of whether the unemployment the economy is currently experiencing is primarily structural or cyclical.
1) Employment Dispersion
If the source of unemployment were structural we should see great dispersion between sectors in terms of employment growth such as we saw in the 1974-1975 recession. That is not the case. Every sector with the exception of utilities, educational and health services, and government, has suffered large declines in employment (about 7%-23%). Employment growth dispersion in this recession is unusually small lending strong evidence that current unemployment is overwhelmingly cyclical, not structural.
2) Job Openings Rate
Not surprisingly, given the lack of disperson in job growth, employers are having little difficulty filling openings. The job vacancy rate has plummeted in this recession from 3.4% in mid 2007 to 1.8% (an all time low) in July 2009 before rising to its current rate of 1.9% as of September. This is hardly consistent with the sectoral imbalance point of view.
3) Unit Labor Costs
Given that employers are having little trouble filling vacancies it should come as no surprise that compensation is no longer rising faster than productivity as would be consistent with a positive inflation rate target. ULC rose by 1.6% annually on average in the ten years through the fourth quarter of 2008. It has fallen every quarter since, down 1.9% as of the third quarter of 2009. This also is not consistent with the structural hypothesis.
The real problem is not a structural problem at all. The real problem is a cyclical problem. When the growth rate of nominal GDP falls sharply (currently down over 8% below trend) there is always a severe recession. We have a severe nominal shock. In such situations, it always looks like the real problem is a structural problem. But the structural problem is itself merely the symptom of a monetary shock, such as financial panic. Thus in the 1930s people thought the collapsing financial system caused the Great Depression, only later did we discover, largely due to Milton Friedman, that it was simply too little money.
Even a major misallocation of resources such as the housing and financial sector boom of 2003-06 cannot cause a big enough recalculation to create a major recession. The initial downturn in housing was handled without so much as a stumble, with only a minor increase in unemployment between mid-2006 and mid-2008 despite a 40% decline in residential investment and a 25% reduction in real housing prices (according to Shiller's historical housing price index). The big jump in unemployment more recently was simply caused by a sharp fall in nominal GDP, in other words, tight money.
Posted by: Mark A. Sadowski at December 30, 2009 04:16 PM
The engine for recovery from the recession is weak or non existent. Typically, housing and autos (interest rate sensitive sectors)with help from the consumer, lead us out of recession. This time housing construction will be little or no help (too many living units) and our domestic auto industry is not likely an engine. The consumer is constrained by slow income growth and unemployment. Commercial real estate lags but becomes an engine within a few months after the start of recovery. This time commercial construction will be losing jobs for the next several years. Government related construction and manufacturing are the only two potential engines.
Many service jobs have been lost in this recession and they do not respond to inventory issues, such as manufacturing. As we have become more of a service based economy; our job recoveries have become much slower (no recent "V" 's).
In essence, there has been something wrong with our job composition starting in the mid '90's. Housing, commercial construction and home equity withdrawal have been the economic drivers over this period. The only other jobs we have been creating are in health care, education and government--these are all a burden on business. We have fewer total jobs now than in 1999 and it looks to me like we have a structural problem. How many years to get back to December 2007? 5, 10?
Posted by: Alex Sinclair at December 30, 2009 06:18 PM
The big problem is FIRE didn't go down enough. These are our new Welfare Mom's, except they cost a lot more.
Mark A. Sadowski ?????
You are living proof that there are parallel universes. So tight money is and was the problem???? Yes , I know that's what the Taylor Rule says lately, but we did do QE to solve that nagging zero bound problem. But I see strip malls on every other street corner and they have a Starbucks at each end. So I always wonder how things got that way.
I hope consumers don't have to give up the right to chose what they purchase, or the responsibility to balance their budgets...so that we can satisfy some one's interpretation of macro-economic theory.
Posted by: Cedric Regula at December 30, 2009 10:03 PM
Many thanks for another interesting note. However, would it be correct to say that your Figure 3 assumes a constant NAIRU (of around 6%)? While Okun's Law might have been originaly stated as an empirical relationship between the output gap and unemployment, the formal statement of the proposition has become Output gap = 2*(unemployment rate - NAIRU) (Abel and Bernanke, I think). If NAIRU is still 6%, then the relationship between the output gap and unemployment still holds. However, the latest CBO estimates of the output gap are still 4.8%. If these estimates were correct, the output gap should be 2.4% larger given the unemployment rate. Isn't this the issue that really concerns Mr Lawler - that the combination of Okun's Law and current estimates of the NAIRU fail to predict the current level of unemployment?
If the NAIRU was still 6% from 1998 - 2008 rather than, say, 5%, should policy rates have been on average 1.0% higher over that period (Taylor Rule)?
Many thanks for any comments/thoughts.
Posted by: Mike Biggs at December 31, 2009 01:23 AM
Mike Biggs: Don't know where you saw that particular estimate of the output gap from the CBO (i.e., what vintage). Last I heard, they were updating the measure of potential GDP to account for BEA's switch to Ch.2005$ -- which is why I used the expedient of following what the St.Louis Fed does, that is adjust the CBO potential measured in Ch.2000$ by 1.14.
You are correct in saying that I used a very simple constant NAIRU assumption in my regression. Allowing in a smooth time-varying NAIRU probably would've improved the fit; however, depending on how "smooth" the variation allowed, the impact on my results would likely have been minor (the smoother the NAIRU evolution, the smaller the impact on our conclusions regarding the size of the employment gap in 2009). But, I admit the use of more sophisticated trend-break or constant-break procedures might yield useful insights, and in the spirit of investigation, I would certainly welcome hearing about them.
Posted by: Menzie Chinn at December 31, 2009 08:33 AM
Menzie Chinn: - Sorry, my mistake - that should have been "the latest CBO estimates of NAIRU are 4.8%". So, if NAIRU is 4.8%, then it is difficult to reconcile the CBO's output gap estimate (of around 7%) with an unemployment rate of 10% (as (10%-4.8%)*2 = 10.4%). The reconciliation works adequately if one believes the NAIRU is 6%, as your chart suggests.
So, the point here is not so much about whether one should or shouldn't use a time-varying NAIRU in one's empirical work, but rather to suggest that what people like Lawler might be claiming is not that the output gap is inconsistent with the unemployment rate, but rather that the output gap is inconsistent with the unemployment rate given the CBO's estimates of the NAIRU.
So, either 1) the CBO's estimates of the NAIRU and the output gap are correct, but the unemployment rate is not consistent with these estimates, or 2) the output gap is consistent with the unemployment rate, but NAIRU is actually around 6.0% or above.
It seems to me you chart supports the latter - and suggests that NAIRU has been around 6% throughout the period. If the Fed has been setting policy with the CBO's 5.0% NAIRU in mind, does this mean policy rates should on average have been 1.0% higher over the last decade? (output gap 2.0% larger than the Fed realised, rates 0.5%2.0% = 1.0% too low).
Posted by: Mike Biggs at December 31, 2009 09:02 AM
I've suspected the existence of a parallel universe ever since I started reading in the econoblogs the neverending warnings of impending hyperinflation, claims that the BEA and BLS stats are utterly meaningless, that supply automatically generates its own demand, that discretionary fiscal stimulus can't work because of Ricardian Equivalence, that we should all delight in economic self-flagellation because it's the Austrian thing to do, etc.
Although structural problems, such as the subprime mortgage crisis, may have helped precipitate the recession, indeed I do think it was poor monetary policy in late 2008 (not 2003-2006 as some have argued) that helped turn what might have been a garden type variety recession into a full blown financial crisis.
In late summer 2007 there were rumblings of problems in the credit markets that caused the Fed to start easing monetary policy. By December it was evident thay weren't easing fast enough. So they dropped the fed funds rate substantially in January 2008 to "lean against the wind." But they were still concerned about commodity price inflation and so after lowering the fed funds rate to 2.0% by April 30th they kept pegged there straight through October 8th as the crisis exploded.
As evidenced by TIPS, inflation expectations started to plummit in early July. In addition manufacturing and commodity prices started to fall and the dollar started to rise versus the euro. These were all signs of tight money, and the Fed should have eased monetary policy further in response to the evolving crisis. But instead they held firm as Rome went up in flames.
I still vividly remember the day after Lehman Brothers went bankrupt. The FOMC met and essentially voted to do absolutely nothing. It was a big "uh-oh" moment for me. By the end of the week the financial markets were in a state of utter meltdown and I wasn't the least bit surprised.
What else makes me say money was tight in late 2008? Because markets expected nominal GDP growth to fall far short of the Fed's implicit target (about 5% a year). But weren't interest rates eventually cut to very low levels? Interest rates are a very misleading indicator of monetary policy. Both in the early 1930s and late 2008, falling rates disguised a tight money policy. The rates were actually falling for two reasons. Expectation of recession led to less borrowing and thus lower real interest rates. And inflation expectations also fell sharply. But didn't the monetary base increase sharply? Yes, but this is also misleading for two reasons. During periods of deflation and near-zero rates, there is a much higher demand for non-interest bearing cash and bank reserves. In addition, on October 6th 2008 the Fed began paying interest on reserves, which caused banks to hoard bank reserves. Consequently excess reserves increased from $8 billion before the payment of interest on reserves to over $800 billion today.
You refer to the Taylor Rule. According to the Glenn Rudebusch's estimate of the Federal Reserves's implicit Taylor Rule:
FFR = 2.07 + 1.28 x Inflation - 1.95 x (Unem. - CBO natur.)
where FFR is federal funds rate, inflation is yoy core PCE and "CBO natur." is the CBO's estimate of the natural unemployment rate or NAIRU which is currently 4.8%.
Today unemployment is 10% and yoy core PCE is 1.4%, thus the FFR should be about -6.3%, an impossibility.
Joe Gagnon estimates that the current amount of quantitative easing is only equivalent to about a 1.5% drop in the fed funds rate. I suspect that it has been rendered so impotent by the payment of interest on reserves. Thus we're still short by about 4.8% in terms of the appropriate fed funds rate by that measure.
The PPI is still down 3.3% from its previous high in July of 2008. It's lower than it was 19 months ago, the longest period without an increase in the PPI in nearly 22 years.
The import price index is still down 15.7% from its previous high in July of 2008. It's lower than it was two years ago, the longest period without an increase in the import price index in over 5 years.
The CPI is still down 0.7% from its previous high in September 2008. It's lower than it was 17 months ago, the longest period without an increase in the CPI since (get this!) 1950.
So, yes, I think money is still very tight.
P.S. I don't think I understand your Starbucks at the strip malls reference. The Federal Reserve's twin mandates are full employment and stable inflation, both of which, in my opinion, they have failed miserably at, of late. There's nothing in there about the number of Starbucks that strip malls should contain.
P.P.S. Sorry, forgive me my occasional sarcasm. ;)
Posted by: Mark A. Sadowski at December 31, 2009 12:13 PM
Mark A. Sadowski,
"The Federal Reserve's twin mandates are full employment and stable inflation....There's nothing in there about the number of Starbucks that strip malls should contain."
But there should be! If they ignore asset prices and signs of gross mis-investment, then they have their heads up their butts. I say an inflation index that ignores asset values, but includes Chinese products, is useless. Actually we may need a suite of indexes to track. And "full employment" is another nonsense term. How do they define that? When we have emptied out Mexico, Central America and India, while shifting all tradeables to China? I don't think the BLS people have ever been to a construction site, IT department, or China.
So that covers 2002 thru 2007. Maybe starting with 1994.
I don't believe in Austrian Economists either, because I think they would all starve to death doing things their way. Supply side worked when the starting point was upper tax brackets above 60%, but we played that for all it's worth already.
I think Milton Friedman is over rated, and inflation and deflation is NOT ALWAYS a monetary phenomenon. You can't simply inflate your way out of deflation or go too far and get hyperinflation as long as you have a credit economy, the caveat being prudent underwriting is necessary. Unless of course the government just absorbs all private debt, then they give everyone no-qual loans and we all go out and jump start the economy.
But I do listen to Roubini, and early on he described this recession as at least half a solvency problem rather than liquidity problem, and monetary policy doesn't compute in that situation.
That is why Ben came up with all his targeted programs, because he was trying to unfreeze markets and prop up "mark-to-market" bank balance sheets because of toxic asset fears. So money supply was secondary. Everyone was scared of the existing paper out there.
Lehman went under because Ben couldn't find any AAA rated assets in the place, which are the current Fed rules to collateralize bailout loans. The money markets, which are supposed to be high quality, froze up when they realized a hedge fund(Lehman) with no assets is dipping in.
GDP and employment is down because the consumer ran into his/her credit limit. Business(ex real estate and fast food franchises) can't make the case for biz investment. RE and FF are all done for a while. This is all because the economy was running above sustainable potential, which is the big picture failure of the Fed this decade. But the rest of the government helped a lot too.
Posted by: Cedric Regula at December 31, 2009 03:31 PM
I've plotted the latest BLS Unemployment data for several of the states with the worst unemployment trends in the current recession to create these heat maps:
Posted by: Pete at January 6, 2010 12:53 PM
What is 'the basic message in figure 2'? It looks to me like sectors that account for about 16% of employment account for HALF of the decline in this recession! The workforce in construction and manufacturing has declined 17% whereas all other employment has declined 4%. In the '80's the composition was very different, so the comparison seems misleading.
I would think the argument for a cyclical effect would be more focused on the higher sensitivity of manufacturing and construction to cyclical declines. Therefore, even though they do have an outsized impact on job losses, we can't say whether that is a cyclical effect or a permanent reallocation effect (resulting in longer term structural unemployment).
Theory tells us the outcome of monetary and fiscal policy depends on the type of unemployment. My own intuition is that there is some of both, but I wouldn't want to set a path of future interest rates or invest a trillion dollars on my intuition. At the end of the day, the post convinces me its not all cyclical and its not all sectoral, but that is cold comfort with regard to appropriate policy responses (is the glass half-full or half-empty now?). The type of unemployment matters in determining the efficacy of types of fiscal stimulus and the correct level of future interest rates. This just reiterates the limits to our understanding (as opposed to justifies some sort of specific policy action).
Posted by: MP at January 9, 2010 03:44 PM
Why is it that economists are steadfastly refusing to acknowledge the elephant in the room?
Specifically, I'm talking about structural unemployment. Even more specifically, I'm talking about the structural unemployment resulting from a decade of jobs created in America, using American resources (including traditional economic resources, such as infrastructure, education of the workers, investment in clean water, etc.), and with the U.S. government providing tax incentives for companies to outsource American jobs.
I've not read any analysis of our current "recession" which includes a discussion of the structural unemployment created by outsourcing American jobs overseas.
Structural unemployment --as we all know-- is where previously employed workers, trained for specific jobs or careers, find (through no fault of their own) that their jobs have disappeared.
It is the most expensive and difficult-to-fix type of unemployment because, up to the time the worker lost their job, our society expended considerable resources that fed, educated and trained the worker for the job which is no longer available.
Society has a vested interest in re-training the structurally unemployed because all of the resources spent up to the time the worker became employed were in preparation for the worker to become a contributing part of our economy.
To deal with structural unemployment, the worker must be retrained to a career that provides income close to what they had before. Any job or career where the worker makes less than before the original job/career disappeared will present a loss on the amount of contributions the worker can contribute to society in the future.
Obviously, this is a very serious problem with our "recession." Yet economists are simply ignoring it.
Should we take this to mean that economists are afraid to even broach the subject? Or that they believe if they just ignore it, it will go away?
Posted by: Morgaine at February 21, 2010 09:05 PM