Not only did NFP employment increase by 243,000, benchmark revisions going back four years (although important revisions were for the last year) raised the December 2011 estimated employment by 266,000. Trend employment continued to rise. This upward shift was also reflected in the research series that is calculated by using household data to generate a series conforming to the NFP concept; the changes are largely due to the application of new population controls (see BLS, Appendix). More on the distinction between the official and research series at here.

With the government shedding jobs, it is perhaps more useful to refer to private employment for underlying labor market trends.

Aggregate weekly hours continue to grow more rapidly than employment; by January, aggregate hours had regained ground such that both employment and hours are now about 4.5% below peak (2007M12) levels.

While private employment continues to grow, government employment continues to fall; the decline is most pronounced at the state and local level (Wisconsin is a good example of the contractionary impact of such measures [1] [2]). However, civilian Federal government employment is also declining.

Finally, it’s useful to examine the trends in multiple labor market series as once. Figure 4 presents one view.

So, for now the trend is positive, but there are clouds on the horizon [Madigan/WSJ RTE]. For more coverage, see [Rampell/Economix] Norris/Economix] [Lahart/WSJ RTE] [Evans/WSJ RTE] [Free Exchange] [Tim Duy] [CR]. A roundup of economist views available from [Izzo/WSJ RTE].

Despite improvement in the labor market, it is clear more needs to be done to accelerate closing the output gap. JEC vice chairman Brady (R) argues:

...It’s time to change course away from higher deficits and higher taxes that are creating fewer jobs and lower expectations for America. Instead, we need to restore confidence by businesses on Main Street to make the new investments in buildings, equipment, and software to create millions of jobs.

Brady and House Republicans continue to push for a balanced budget, fairer tax code, more balanced regulation and reforms to make Social Security and Medicare solvent for the long term.

This perspective shares intellectual lineage with the underpinnings of the Ryan plan, examined here the JEC expansionary contractionary fiscal scenario here. An examination of the other propositions of equal empirical deficiency -- regulation reduction and growth, and regulatory uncertainty reduction and growth -- examined here and here, respectively.

In my opinion, Representative Brady's prescriptions will, like the contractionary fiscal policies implemented in Wisconsin [3] [4], reverse rather enhance the employment recovery seen thus far [5] (i.e., textbook macro applies).

Figure 1 confirms that the real exchange rate lagged two years has a measurable correlation with the ex-oil trade balance. I’ve documented the evidence for a causal effect in several previous posts. One new observation I’ll make is that the unit labor cost deflated real exchange rate is more highly correlated with trade balance movements than the conventional CPI deflated. Theory suggests that the ULC deflated measure would better measure international competitiveness. [paper] The practical matter is that unit labor costs are available for a subset of countries (typically developed), so the unit labor cost index does not incorporate Chinese costs.

Eyeballing Figure 1 suggests that the trade balance should continue to improve, given depreciation of the dollar to date. Of course, rest-of-world growth matters as well, so that conjecture is conditional.

Recalling unit labor costs equal output per hour (productivity) divided by nominal compensation, it’s useful to inspect US productivity trends.

Notice productivity continues to grow, and has recently outpaced real compensation (deflated using the sector deflator, not the CPI). This suggests to me continued pressure for improvement in the trade balance, as competitiveness continues to improve. The wild card in the analysis is of course China. In that case, we don’t have a clear idea of unit labor costs in the tradable sector. [2] [3]

Other commentators have noted that while exports might continue to increase, it’s not clear manufactured exports will. Figure 3 plots cumulative changes in real exports vis a vis 2009Q2.

Clearly, export growth is decelerating -- not surprising given the collapse in trade volumes that took place during the great recession. Nonetheless, I find it interesting how much capital goods exports have increased. Now, as I mentioned in an earlier post, vertical specialization means that it’s unclear how much value added is incorporated in particularly the goods exports. Still, I think there is evidence for a manufactured exports rebound.

Finally, there has been substantial skepticism that manufacturing employment will rebound strongly, even if the President’s initiatives outlined in the State of the Union are implemented. [4] I think that skepticism is largely warranted, given rapid productivity growth in that sector. However, that doesn’t mean that manufacturing value added won’t necessarily rebound. BEA only released data up to 2010 last month, so one can’t be sure. Extrapolating using quarterly BEA output data to 2011Q3, and Fed manufacturing data through December 2011, one can obtain the plot of manufacturing value added and GDP in Figure 4.

So while GDP is less than a percentage point above 2007 levels, manufacturing output is 2% above. This is notable given the trend decline in real manufacturing to real GDP. Hence, I think that a continued decline in the dollar’s value conjoined with continuing productivity growth will induce rebalancing toward greater manufacturing value added – both by way of greater exports and fewer imports. To the extent that wages in manufacturing tend to be higher than in retail and distribution, the spillover effect from higher manufacturing output might be disproportionate.

Of course, I think the more relevant question is the output and employment in the tradable sector. See here and here.

Here are the percentages of 58 economics bloggers surveyed by the Kauffman Foundation who were in favor or opposed to a half-dozen specific policy proposals.

Veronique de Rugy (hat tip: Political Calculations) finds that only half the people who file tax returns with over a million dollars in income still have over a million dollars in income the next year, and only 20% stay in the millionaire category for longer than 4 years.

From the document:

The major tax expenditures considered here fall into four categories—exclusions from taxable income, itemized deductions, preferential tax rates, and tax credits. Of those tax expenditures, four are exclusions of certain types of income from individual income taxes: employers’ contributions for health care, health insurance premiums, and long-term care insurance premiums for their employees; contributions to and earnings of pension funds (minus pension benefits that are included in taxable income); unrealized capital gains from assets that are transferred at the owner’s death; and untaxed Social Security and Railroad Retirement benefits. Employers’ contributions for health insurance and contributions to pension funds are also excluded from payroll taxes.

The exclusion of employers’ health insurance contributions is the single largest tax expenditure in the individual income tax code; including effects on payroll taxes, that tax expenditure is projected to equal 1.8 percent of GDP over the 2013–2022 period (see Figure 4-5). The exclusion of pension contributions and earnings has the next largest impact, generating net tax expenditures (including effects on payroll taxes) estimated to total 1.1 percent of GDP over that period.14 The exclusion of unrealized capital gains at death is projected to generate tax expenditures equal to 0.3 percent of GDP over those 10 years, and tax expenditures for the exclusion of untaxed Social Security and Railroad Retirement benefits are projected to equal 0.2 percent of GDP.

Three other major tax expenditures allow taxpayers who itemize deductions to deduct their spending for certain items from their taxable income. The deduction for interest paid on mortgages for owner-occupied residences is the biggest of those three; tax expenditures for that deduction are projected to equal 0.8 percent of GDP between 2013 and 2022. By comparison, the tax expenditures for deductions for state and local taxes and for charitable contributions are each projected to equal 0.3 percent of GDP over that period.

Some forms of income are subject to preferential tax rates under the income tax. Both long-term capital gains and dividends are taxed at lower rates in 2012 than other forms of income. Although the preferential rate on dividends is scheduled to expire at the end of December 2012, a slightly higher preferential rate on long-term capital gains will continue after that. Tax expenditures for those preferential rates on dividends and long-term capital gains are projected to total 0.5 percent of GDP between 2013 and 2022.

The other major tax expenditures projected by CBO are two refundable tax credits, both targeted toward households with children. ...

The magnitude of these expenditures, relative to the Nation's tax revenues and outlays. That is why Jeffry Frieden and I stressed the need for dealing with these tax measures, in addition to increasing tax revenues (such as by letting all the provisions of the 2001 and 2003 tax cuts expire) in our book, Lost Decades. Previous discussion of tax expenditures also in this post.

The relative importance of these various tax expenditures is illustrated in Figure 4-5.

For more on tax expenditures, one should also see Part II (specifically Chapter 10: "Spending through the tax code") in Bruce Bartlett's excellent new book, The Benefit and The Burden: Tax Reform-Why We Need It and What It Will Take (Simon and Schuster, 2012) (reviewed positively in Forbes, among other places). Bartlett provides a narrative history explaining why many of these tax expenditures came to be, thus contextualizing these otherwise sometimes inexplicable provisions.

More on the CBO Outlook later.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate.

This represents an important step in the direction of an explicit inflation target, which some academic research suggests might help lead to greater financial stability. It's very useful to connect this statement of longer run goals with other details released last week on what the Fed is expecting over the next several years. A key takeaway from the latter is the Fed's expected behavior for the PCE deflator:

So the FOMC is saying that it would like inflation to be about 2% annually, but is expecting it only to be 1.4 to 2.0% over the next 3 years. Putting 2 and (less than) 2 together, the FOMC is telling us that, based on its price stability objective alone, the Fed is expecting inflation to be lower than it would like. In other words, even if the economy were at full employment, a little more stimulus would be called for. And of course, nobody thinks the U.S. is anywhere close to full employment. The Fed's forecast is for an unemployment rate between 7.4 and 8.1% for 2013.

Interpretation: the Fed is expecting to exert some additional stimulus. Large-scale asset purchases-- referred to popularly as more "quantitative easing"-- are the primary tool available. So, if your motto is "don't bet against the Fed," then I wouldn't bet against more QE during 2012.

But what's the Fed waiting for? One issue is that although the Fed is expecting inflation to be below target for the next 3 years, and although the actual inflation rate has come in below their announced target over much of the last 4 years, since last April the year-over-year change in the PCE deflator has been running a bit above 2%.

Year-over-year percent change in monthly PCE deflator, 1960:M1 to 2011:M1. Horizontal line at 2.0%. Data source: FRED.

The Fed is not alone in thinking that inflation will be lower over the next few years than it was in 2011. For example, the median respondent to the Federal Reserve Bank of Philadelphia's Survey of Professional Forecasters is anticipating 1.6 to 1.8% annual headline PCE inflation for 2012 and an average over 2011-2015 of 2.1%. A new survey by the Federal Reserve Bank of Atlanta found that businesses in the southeastern United States are on average expecting their costs per unit this year to rise by 1.8%. And expected inflation as inferred from the gap between nominal and inflation-protected 5-year Treasury securities has been coming in below 2% since last summer.

Difference between 5-year nominal and 5-year TIPS yields, monthly averages, 2003:M1 to 2011:M12. Data source: FRED.

But although professionals may be inclined to agree with the Fed, ordinary Americans seem less so. The University of Michigan survey of consumer attitudes has been reporting expected inflation rates that are a hundred basis points higher than the professionals.

Source: Federal Reserve Bank of Cleveland.

Why worry about inflation at all, even if the public is right and it turns out to be 3%? Here I think the key question is the limits on what the Fed could do to help. Do higher inflation rates really help the economy, and, once we open that door, could the Fed keep it under control without further economic damage? As long as there is a non-neglible prospect of outright deflation, there's no question in my mind that trying to get a little more inflation is a good idea. A Fed policy of communicating clearly that they're simply not going to allow deflation has always made a lot of sense to me. But once inflation goes above 3%, it's far less clear that more monetary stimulus can do any good.

Could the Fed forge ahead anyway, with a communication strategy of, "yes, we know many of you are expecting higher inflation, but we're the experts and we say you're wrong". Unfortunately, a key element of the success of anything the Fed tries to do is that the market has to believe the Fed can and will carry out what it says. Credibility is the only reason that the Fed's announcement that conditions "are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014" has any effect at all. For that matter, the market signal that is generated by large-scale asset purchases may be a key mechanism by which QE itself makes any difference. Without credibility, the Fed is only a paper tiger. The more political opposition the Fed faces, the less it can actually accomplish.

The Fed would like to do more, and expects it may soon have to do more. But it isn't ready to act quite yet.

Tonight I'm happy to report that after three years of losing 150,000 jobs Wisconsin actually added thousands of new jobs in 2011. New business formations are up by over 2 percent. And our unemployment rate is down from a year ago.

In fact, Wisconsin’s unemployment rate is not only lower than the national average but much better than our neighbors to the south in Illinois.

Figure 1 provides a comparison of Wisconsin's performance, in terms of economic activity, using data released on Thursday by the Philadelphia Fed.

Figure 2 provides the private nonfarm payroll series for Wisconsin (in contrast to the civilian employment series stressed at certain points by the Governor).

Nonfarm payroll employment also exhibits a similar pattern. See [1].

While it is true that civilian employment (which includes self-employment, farm employment, government employment) has risen, it has risen more slowly than the national series. The US series is 1% above 2011M01 levels, while the Wisconsin series is 0.7% above (in log terms); moreover, the Wisconsin civilian employment series remains 0.2% below the May 2011 levels.

Further, while unemployment rates have fallen in both Wisconsin and in the US, it's important to recall the unemployment rate is the ratio of two variables (employment, measured labor force), and hence can move as a result of either variable moving. The labor force has shrunk noticeably (half a percentage point) in Wisconsin over the last six months, while it has risen in the US slightly. In this sense, the unemployment rate is a less informative indicator than some others.

Returning to the macroeconomic indicators for Wisconsin, the Philadelphia Fed provides this map identifying three month trends:

According to this map, Wisconsin is indeed moving in a direction.

Other Wisconsin news: [2] [3] [4]

Real GDP growth at an annual rate, 1947:Q2-2011:Q4, with dates of U.S. recessions as determined by NBER indicated as shaded regions. Blue line represents historical average growth of 3.2%.

A key reason to be concerned about continuing below-average GDP growth is Okun's Law, which originally held that to get the unemployment rate to decline by 1 percentage point, we'd need a year of GDP growth 3% above average. Okun based that estimate on data for the U.S. economy prior to 1960, but it has held up pretty well in the half century since then, with 2.5% above-average GDP growth a better summary of the requirement based on the full sample of data now available. Using data from 1949:Q1 to 2011:Q4, here's a quarterly regression of the year-over year change in the unemployment rate on the year-over-year percent change in real GDP (Newey-West standard errors with 8 lags in parentheses):

Vertical axis: change in unemployment rate between last month of the quarter and value for same month in the preceding year. Horizontal axis: 100 times the change in the natural logarithm between U.S. real GDP in a given quarter and the value for the same quarter of the previous year. Line plots regression equation above.

According to the above relation, if real GDP grows by less than 3.3% over a year, the unemployment rate is more likely to rise than fall. The fact that the unemployment rate fell by 0.9 percentage points in 2011 despite GDP growth of only 1.6% for the year is thus a little surprising, and attributable in part to a declining labor force participation rate. If we want to see real progress in 2012, we have to hope for better GDP numbers than we had for the fourth quarter.

Source: Federal Reserve Bank of St. Louis

Though disappointing, 2.8% real GDP growth would unambiguously be characterized by economists as expansion rather than recession. The latest GDP numbers helped bring the Econbrowser Recession Indicator Index down to 7.4%. For purposes of calculating this number, we allow one quarter for data revision and trend recognition, so the latest value, although it uses today's released GDP numbers, is actually an assessment of where the economy was as of the end of the third quarter of 2011. The index would have to rise above 67% before our algorithm would declare that the U.S. had entered a new recession.

GDP-based recession indicator index. The plotted value for each date is based solely on information as it would have been publicly available and reported as of one quarter after the indicated date, with 2011:Q3 the last date shown on the graph. Shaded regions represent dates of NBER recessions, which were not used in any way in constructing the index, and which were sometimes not reported until two years after the date.

Another disappointment in the latest GDP numbers is that inventory accumulation accounted for 1.9 percentage points of the 2.8% 2011:Q4 growth rate-- we were producing more goods, but not succeeding in selling them to final buyers. Also noteworthy is the -0.9% contribution from lower government spending at the federal, state, and local levels. I know you've heard this before, but it doesn't hurt if objective analysts keep repeating the obvious: fiscal contraction is contractionary.

In my view, this is pretty much the nail in the coffin that an expansionary fiscal contraction will occur, even in a relatively small, open economy with a flexible exchange rate (see JEC/Republicans for an exposition, and this post for a critique).

Simon Wren-Lewis at Mainly Macro provides additional commentary, which I think advocates of austerity in the US would do well to heed:

The first estimate of UK growth in the last quarter of 2011 was negative. As these updated NIESR charts show, no other UK recovery has stalled in this way. Of course very little is ever certain, but we can be pretty sure that growth would have been significantly better if the current government had not imposed severe additional austerity measures beginning in 2010. (This is the counterfactual that matters, and just looking at GDP components can be a misleading way at getting at this for reasons I discussed here.) Of course growth might have been better too if the Euro crisis had not happened, but this government had no control over the Euro crisis, while it does decide fiscal policy.

I do not have anything very new to say about this, in part because many people predicted growth would be harmed before the policy was introduced. (See, for example, this letter from 80 economists published during the 2010 election campaign.) What was the reason for this major macroeconomic policy error? For some I think it was a political calculation that it would be advantageous to get as much of the cuts out of the way early, well before the next general election. However I think others in the coalition were genuinely spooked by events in Greece and elsewhere. Unfortunately the key difference between economies in the Eurozone and those with their own central bank was not appreciated. Today the claim that if these additional austerity measures had not been introduced UK interest rates on debt would have suffered the same fate as many Eurozone countries looks pretty implausible. In Denmark we even have an example of a country that has recently undertaken stimulus measures, and where interest rates have continued to fall in line with other countries outside the Eurozone (see David Blanchflower here).

So I believe we must add 2010 to a list of major macroeconomic policy errors made in the UK since the war. Like the failed monetarist experiment in the early 1980s, it is the result of a government adopting a policy which relied on a mistaken macroeconomic analysis that was not supported by the majority of academic opinion. And like that earlier failure, it will leave unemployment significantly higher than it need to have been for many years.

So, time for those in the US calling for an end to the payroll tax reduction, the reduction in food stamp programs, and cessation of stimulative monetary policies, to read a macroeconomics textbook. I suggest Greg Mankiw’s.

[T]rue fiscal responsibility involves a willingness to raise sufficient tax revenue, over the longer term, to pay for the programs the government implements. Fiscal responsibility should not be equated with a small government, but rather with a commitment to pay for the government services provided. ...

... If the nation affirms that enhancing national defense and improving health care for the poor are legitimate goals, fiscal responsibility entails raising the revenue to fund these programs, rather than borrowing for them. (Chinn and Frieden, Lost Decades, 2011, pp. 202-03.)

Here is a summary of the scoring of candidates plans by the Tax Policy Center, as reported by Cooper and Kocieniewski in the New York Times (January 18, 2012).
Source: [link]

From the article:

It is not unusual for Republican presidential candidates to call for tax cuts that would expand the deficit: They argue the cuts will spur the economy. But they are now calling for tax cuts in a year in which Washington and many Republicans have been consumed by talk about reducing the deficit. It was only last summer that House Republicans balked at raising the nation’s debt ceiling, citing alarm about high deficits -- a move that brought the nation uncomfortably close to a default and led Standard & Poor’s to lower the nation’s credit rating.

By reducing the amount the federal government collects in taxes each year -- at a time when federal tax collections are already a smaller share of the economy than they have been in more than half a century -- the Republican tax plans will make it harder to balance the budget, said Robert L. Bixby, the executive director of the Concord Coalition, a nonprofit group that advocates fiscal responsibility.

"If the first thing you do is lower revenues by that much by extending all of those tax cuts, then you have a much bigger hole to dig out of to get back to a balanced budget," he said in an interview. "The hole they’re digging, to mix metaphors, is a self-inflicted wound."

The tax picture can be visualized by way of plotting the tax revenue to GDP ratio.

Figure 1: Federal government taxes and contributions to social programs (blue), and current expenditures (red), both as a share of GDP. NBER defined recession dates shaded gray. Source: BEA, 2011Q3 3rd release, NBER, and author’s calculations.

Note that total tax revenues (income taxes and contributions for social programs) are at very low levels. By way of contrast, expenditures are high, but not that much higher than those recorded during the Reagan Administration. That peak was at the end of recession, so the operation of automatic stabilizers and the defense buildup were important, while the current reading is several quarters into a plodding recovery. One can plot the tax and expenditure series against potential GDP. Then the prior peak in spending to potential GDP was in 1986Q3, several years into the recovery. What remains true is that the revenue to GDP ratio remains very low. And they have been trending lower ever since the 2001 and 2003 tax cuts implemented during the Bush Administrations (EGTRRA and JGTRRA, respectively).

Figure 2: Federal government taxes and contributions to social programs (blue), and current expenditures (red), both as a share of potential GDP. NBER defined recession dates shaded gray. Source: BEA, 2011Q3 3rd release, CBO, Budget and Economic Outlook: An Update (August, 2011), NBER, and author’s calculations.

Given these trends, it is implausible that any tax cuts of the proposed magnitudes can be reconciled with balancing the budget by way of spending cuts.

Unless, of course, one uses a simulation from the Heritage Foundation’s Center for Data Analysis [1] [2] [3] [4]. Then anything is possible.

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