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Wednesday, September 08, 2010

"The Dramatic Jump in the Actual Unemployment Rate [is] Largely a Cyclical Phenomenon"

Minnesota Fed president Narayana Kocherlakota says once again that there's little that monetary policy can do for the unemployment problem because it's largely structural (here's Brad DeLong's reaction, see here too). However, researchers at the Cleveland Fed say their estimates tell a different story:

The dramatic jump in the actual unemployment rate we have observed since the beginning of the recession is being interpreted in our flows-based analysis as largely a cyclical phenomenon, with little movement in the long-term rate. The long-run trend does appear to have increased from its prerecession level, but by only a small margin.

The natural rate of unemployment is not 9.6 percent, the current unemployment rate. It's not even close to that (the Cleveland Fed says it's "roughly 5.6 percent to 5.7 percent"). But even if it was as high as 7.5 percent (to be clear, this is a hypothetical), are we just going to give up on the other 2.1 percent? I think that the cyclical component is a lot larger than 2.1 percent, and that even if there is a sizable structural problem there are still things we can do to help the structural transition along, including using low long-term interest rates to encourage the investment that helps that structural change happen faster. But even if you think the natural rate has increased quite a bit, and there's nothing the Fed can do for the structurally unemployed, it hasn't gone up as high as 9.6% and there's no reason to give up on those who can be helped.

And they do need help. As the Cleveland Fed notes in the link given above, even though the problem is largely cyclical in their view, it's looking like a long recovery is ahead:

Since we have not seen a big rise in the long-term unemployment rate, we might expect to converge to this “natural” rate soon. Unfortunately, this is not likely to be the case, and there are several reasons to suspect that the adjustment might take a long time. The first is the sheer extent of the gap between the current and long-term unemployment rates, regardless of the specific long-term rate one believes holds (figure 6). ... When the U.S. economy experienced a similar-size gap after the 1981–1982 recession, it took several years for the observed unemployment rate to drop to levels closer to the trend.
And it might be even harder for the labor market to adjust this time around. The rate of adjustment depends on how fast workers are reallocated between unemployment and the available jobs. The slower rates of worker reallocation we have found may act to slow the closing of the unemployment gap.
There are other reasons to believe that unemployment rates may stay well above the long-term rate for an extended period of time. Because of the length of the recession, there is a considerable number of potential workers who are not formally in the labor force. We have seen one of the sharpest drops in the labor force participation rate in the postwar data, as many unemployed workers simply stopped looking for a job. If some of these discouraged workers decide to search for a job as aggregate economic activity picks up, unemployment might decline at an even slower rate because the pool of unemployed workers is being replenished with workers re-entering the labor force.
Another concern raised by our findings is the negative impact of long-term unemployment on the human capital of the workforce. Longer unemployment spells are a problem because unemployed workers who are unemployed for too long can lose industry- and job-specific skills. Losing skills can reduce their odds of finding a job during the recovery as well as lower their productivity when they finally do find one.
Ultimately, an increase in the demand for labor will determine how fast the unemployment stock will be depleted. ...

Continuing the last point, we are simply not doing enough to create the labor demand that is needed. And, unfortunately, the claim that the problem is almost all structural and therefore there's little we can do is one of the things standing in the way of giving labor markets the help that they need.

    Posted by on Wednesday, September 8, 2010 at 04:08 PM in Economics, Fed Speeches, Monetary Policy, Unemployment | Permalink  Comments (39)

          


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