My reaction to Bernanke's speech:
What would you add?
My reaction to Bernanke's speech:
What would you add?
I see that the issue of structural versus cyclical unemployment is rearing its head again. Here's something I posted at MoneyWatch a couple of weeks ago on this topic:
Is the Unemployment Problem Cyclical or Structural?: As I noted in a previous post, economists define three types of unemployment: frictional, structural, and cyclical:
Frictional unemployment is defined as the unemployment that occurs because of people moving or changing occupations. Demographic change can also play a role in this type of unemployment since young or first-time workers tend to have higher-than-normal turnover rates as they settle into a long-term occupation. An important distinguishing feature of this type of unemployment, unlike the two that follow it, is that it is voluntary on the part of the worker.
Structural unemployment is defined as unemployment arising from technical change such as automation, or from changes in the composition of output due to variations in the types of products people demand. For example, a decline in the demand for typewriters would lead to structurally unemployed workers in the typewriter industry.
Cyclical unemployment is defined as workers losing their jobs due to business cycle fluctuations in output, i.e. the normal up and down movements in the economy as it cycles through booms and recessions over time.
In a recession, frictional unemployment tends to drop since people become afraid of quitting the job they have due to the poor chances of finding another one. People that already have another job lined up will still be willing to change jobs, though there will be fewer of them since new jobs are harder to find. However, they aren't counted as part of the unemployed. Thus, the fall in frictional unemployment is mainly due to a fall in people quitting voluntarily before they have another job lined up.
But the drop in frictional unemployment is relatively small and more than offset by increases in cyclical and structural unemployment. One of the big questions right now is whether the US economy is suffering, for the most part, from structural or cyclical unemployment. If it's cyclical, then there's a good chance that government intervention can help. If it's structural, i.e. a decline in automobile production and manufacturing more generally, a decline in home construction, and a decline in the financial industry all of which free workers that need to be absorbed elsewhere in the economy, there's less that can be done and some do not think that government can do much at all about this type of problem (though as I note below, I disagree). Thus, the debate is between those who say our current unemployment problem is largely cyclical and hence we need more government action, and those who say it's structural and hence there's very little that government can do. We will just have to wait for the structural changes to take place, and that takes time.
I don't think this debate can be answered by moving close to the polar extremes and declaring it's mainly a structural or cyclical problem. For me, it seems obvious that part of the problem is structural. The real question is how large the structural component is and what can be done about it. But no matter how large it is -- take a very liberal estimate of the size -- I don't think there's any way to deny that there is a substantial cyclical component on top of it that demands government action. It's true that the size of the government action to offset the the cyclical downturn should be connected to the size of the cyclical unemployment problem, but the problem is big enough that politicians won't come anywhere near to overdoing it. The most optimistic view of what Congress might do would still leave them short of what is needed. We don't know the exact structural-cyclical breakdown, but the cyclical problem is certainly larger than any imaginable Congressional response. So the excuse for inaction based upon the "it's all structural" claim isn't persuasive.
What about the structural problem, does government have any role to play, or does it have to rely upon the private sector to solve this problem by itself? Several points on this. First, even if the problem is mostly structural, the government can still provide people with jobs to bridge the gap until the structural changes are complete. To me, this is better than simply extending unemployment compensation since it allows individuals to contribute something (e.g. work on a project the local community needs). And by giving people jobs, or at least government aid through unemployment compensation, we increase aggregate demand and the that helps firms to do better and speeds the transition.
Second, government can ease the structural problem by making it easier for businesses and individuals to relocate. People are understandably reluctant to leave the place they have lived for years and years, but government incentives to relocate (tax breaks, subsidies, etc.), can help. So can efforts to provide individuals in communities suffering from high unemployment with information about where job prospects are better, as can retraining programs (though these aren't always as effective as hoped). In a deep, widespread recession places that need workers may be hard to find, but not always and knowing where there are better opportunities for employment can be helpful. Businesses can also be induced to relocate through tax and other incentives, though the tax competition that accomplishes this may strip local governments of needed tax revenue, so I'd prefer these programs originate at the federal level. And there can also be government encouragements to speed the investments that are needed to complete the transition.
But the main things I want to emphasize are that no matter how large the structural problem is, cyclical unemployment is also a big problem, so the claim that government is powerless because it's all structural doesn't hold. And the claim that the existence of a structural problem means there's nothing the government can do is also incorrect. If nothing else, the government can help workers during the transition. In addition, though the opportunities here are more limited, there are also things the government can do to make the transition happen sooner rather than later.
I have a new post at MoneyWatch:
If it's mainly cyclical, does that mean the government is powerless to help?
Some thoughts on why the administration did not fight very hard for more stimulus, and the cost of that decision:
I'm disappointed to see the administration, and more importantly the economy, in a position that could have been avoided.
I have a new post at MoneyWatch:
It responds, briefly, to today's report on new claims for unemployment insurance, but the main discussion follows up on a post from Paul Krugman and looks at how effective further monetary policy initiatives might be.
I don't have anything to post, so until I do, here's something I posted at MoneyWatch a few days ago. The post addresses the latest proposal for financial reform, in particular the proposal to change the way the District Bank presidents are chosen in an attempt to reduce the power banks have over monetary policy. One part of the proposal was to have the NY Fed president chosen by the president rather than the NY Fed's Board of Directors because of the NY Fed's special role in the implementation of national monetary policy. One question I ask at the end of this post is whether the NY Fed needs to have a special role in monetary policy and be elevated above all other District Banks. Why can't the execution of monetary policy be housed in a separate agency under the control of the FOMC (or, alternatively, the Board of Governors)? There was a time when proximity to Wall Street was essential, but that has changed in the last 70 years, and, in any case, the agency could be located as close to Wall Street as needed. Communication with Washington, to the extent it's needed, could us digital technology. This would put the NY Fed on a more equal footing with the other Fed's, and solve the problem of how to represent both regional and national interests in the selection of the NY Fed president:
Reducing the Influence Banks Have over Monetary Policy: There's some news on the Dodd proposal for financial reform, something I wrote about when the details of the proposal initially came out.
This is a post that appeared on my MoneyWatch blog, but upon further reflection, I'm not so sure about this one -- maybe I was in too much of a rush. I was supposed to be traveling to a conference in Europe today, and I needed posts that I could set to appear automatically while I was traveling, so I figured I'd set this one for about the time I was taking off for Budapest. That way, I'd have a good reason to ignore the inevitable comments telling me what an idiot I am -- even if I tried, travel would make it hard to get to them. However, I had to cancel the trip at the last minute, and I thought about canceling this post too. But what the heck, I'm never satisfied with posts after the fact, so I'll post it anyway. Maybe it's OK after all.
The post argues that perhaps we were in too much of a rush to pass financial reform legislation, and that explains the disappointing outcome. But what made me reconsider was an argument I read somewhere along the lines that "it took all this time to get legislation done, and this is the best they could do?" I still think that in legislative time, this was undertaken relatively quickly, that more patience might have helped, but it has been several years since we knew their were big problems to solve so it's not as though the legislation was rushed from day one. In any case, the main question I want to take up now is the quality of the legislation we're likely to get:
Reconsidering the Rush to Reform the Financial Sector, Maximum Utility: I wish I could say that the financial reform legislation that is under consideration in Congress makes the best possible attempt to insulate the financial system from problems in the future, but I can't make that claim. The legislation still needs to go through reconciliation to bring the House and Senate versions together, but the reforms that appear set to be enacted feel like a hodgepodge of measures rather than a set of consistent laws and regulations designed to counteract the fundamental failures within the financial system. The policies that emerged seemed to depend on what was possible rather than an overriding sense of the fundamental issues that needed to be addressed.
I had hoped that financial legislation would proceed by first identifying the major problems that caused the crisis or amplified its effects, and then by putting specific measures into place designed to fix those problems. But that's not how it went. Instead, it seemed like it was a little bit of this and a little bit of that with no real sense of overall purpose.
Maybe we were in too much of a hurry. I was one of those who made the following argument:
Kashyap and Mishkin ... may be right that now is not the time to change regulations because it could create additional destabilizing uncertainty in financial markets, and that waiting will give us time to see how the crisis plays out and to consider the regulatory moves carefully. But as we wait, passions will fade, defenses will mount, the media will respond to the those opposed to regulation by making it a he said, she said issue that fogs things up and confuses the public as well as politicians. By the time it is all over there's every chance that legislation will pass that is nothing but a facade with no real teeth that can change the behaviors that go us into this mess.
I thought that if we didn't hurry up and do something, we wouldn't get anything done at all (as passions fade, etc.), so it was better to go forward and perhaps get imperfect legislation than to wait and get nothing at all.
I wanted to strike while the iron was hot, but what I underestimated is the ability of politicians to heat things up. That's what politicians do, they create the passions that allow legislation to go forward (or to block it as the case may be). I am not claiming that the timing of the announcement of the Goldman Sachs investigation was politically motivated, i.e. connected to the reform legislation that was being considered in Congress, but it did show how easily passions can be inflamed with the right triggers. Politicians and their allies in the media are experts at finding and exploiting those triggers, so perhaps I was in too much of a hurry to push financial regulation forward. Patience may not have been so costly in terms of waning support as I first thought, and it may have allowed us to better identify the problems in the financial sector and then find the solutions that are needed to insulate it from further problems.
We couldn't have waited too long. It's still true that things fade over time, including the ability of politicians to whip up passion on an issue, but perhaps a little more patience would have produced legislation that does a better job at first identifying the problems that need to be fixed, and then crafting specific, workable regulatory solutions to those problems. I'm still not fully convinced that waiting longer was the right thing to do. I still worry that it gives the opposition too much time to put up obstacles to reform -- the opposition can whip up the public's passion too -- and that the public's anger fades over time. But seeing the legislation that actually emerged, and having the sense that it is not as effective as it could be due to the somewhat ad hoc way it was put together, I'm much more open to arguments that patience would have produced a better outcome than I was before.
I'm clearly not all that impressed with the legislation. I don't think the leverage restrictions are tough enough, I don't understand why we allow firms with enough political and economic power to manipulate their environment to persist, the ratings agencies need reform (though there is some progress here), there are incentive problems throughout mortgage and financial markets that need to be fixed, and the legislation is not as focused, cohesive, and encompassing as it should be.
What's your view on the legislation that is likely to emerge from reconciliation? Is it as good as we can expect, or is it far short of what could and should have been accomplished?
Just posted at MoneyWatch:
I argue the answer depends upon the question we are asking, but yes, these jobs count in an important way.
Just posted at MoneyWatch:
Rethinking the timing of financial reform legislation. Were we in too much of a hurry?
New post at MoneyWatch:
Tax cuts can be particularly helpful in "balance sheet recessions".
What Economic Policies Should Government Pursue During the Recovery?, Maximum Utility: Now that the economy appears to be turning around, how should the government react? What types of policies are needed for the recovery period?
1. Things look better now. Almost all economic indicators are beginning to point upward, but we don't know yet if the recovery will be strong or weak, or if we might be headed for a double dip. For that reason, don't pull back on monetary and fiscal stimulus too soon. It will be tempting to listen to the deficit and inflation hawks as things start to improve, but it's important that the stimulus not be withdrawn before the economy can stand on its own.
2. If the recovery seems to be very slow or stagnating, don't be afraid to give the economy the additional help it needs. Output is starting to grow, but labor markets are lagging behind. It's not yet clear if the lag will be as large as in the previous two recessions, but it's certainly something to keep an eye on.
3. Similarly, there is a huge jobs backlog -- millions and millions of people have lost jobs during this recession -- and it will take a considerable amount of time to reemploy these workers even under strong labor market conditions. Workers will still need unemployment compensation, help with health care, and other social services until they can find work. They are not lazy or playing the system, it's just that the applicant to jobs ratio will remain high until the backlog is cleared, so don't cut them off too soon.
4. If the government does try to take an active rather than a passive role in the recovery, try to anticipate what the post-recession economy will look like and help with the adjustment. For example, there is lots of structural unemployment due to the scaling down of the housing and financial industries. Where will these workers go and what can the government do to help them get there? Will we need to rely upon exports to a greater degree than before the recession in order to maintain robust growth? If so, what can the government do to help this sector to develop? I don't mean the the government should try to manage the economy with a heavy handed industrial policy approach, but when it's clear that change is coming to a particular sector, then the government should do what it can to help (or at least get out of the way).
5. As the economy recovers, it will be easy to forget about the problems we had and what caused them. Don't let exuberance over the recovery get in the way of making the changes that need to be made to try to prevent this from happening again. All of the promises to do better that are made when things are really bad are easily forgotten once things improve.
6. When the time comes -- but not a moment before that -- policy must be reversed. The fiscal policy measures involving both government spending and tax cuts were sold as "targeted, timely, and temporary." We could have done better at the targeted and timely part, but it's not too late to make it temporary. It will be difficult to cut the stimulus once it's clear that the economy has recovered, there will be an outcry about the jobs that will be lost, the decline in growth, etc., but it's important that we do it. First, there are theoretical reasons to believe that temporary fiscal policy has a much larger effect than permanent changes within modern, New Keynesian structures. Second, we may need fiscal policy again someday. If we don't keep out promises and reverse the spending and tax cuts, the next time fiscal policy is needed nobody will believe that will actually be temporary no matter what is promised, and that will make it much more difficult to pursue the policy that is needed.
Update: 7. State and local governments are still having trouble, and are likely to continue to struggle at least through the next fiscal year. If they don't get more help, this create a big drag on the recovery.
This is surely incomplete. What else should be on the list?
I have a new post at MoneyWatch:
Growth Policy versus Stabilization Policy: In economics, as in other disciplines, the important questions change over time. In macroeconomics, there are two big questions and our attention to one or the other changes with the economic events of each era. One question concerns stabilization policy -- keeping the economy as close as possible to the long-run growth path -- and the other is growth policy, i.e. policy that attempts to maximize the long-run growth rate. (There is also work on whether stability and growth are related. More stable economies could grow faster due to reduced uncertainty, but government intervention to stabilize the economy could also stifle growth according to some models, so the relationship is not clear a priori.)
We could go back further than this, but let me pick the story up in the 1970s. ...[continue reading]...
The argument is that we have paid too much attention to growth policy, and not enough to stabilization. Even if the growth policies do pay off in the long-run, the over emphasis on growth has caused a slower recovery and it's not at all evident that's a desirable trade off.
This is a list of my posts at CBS MoneyWatch:
[This is just so I have them all in one place (though it won't hurt my feelings if you decide to read one of them). I started a MoneyWatch category for posts not too long ago to make the posts easier to find later, and this is faster than going back and trying to add the tag to all the references to MoneyWatch posts that appeared here.]
New post at MoneyWatch in reaction to today's 96-0 vote in the Senate to audit the Fed:
I argue that Congress should try to look like it is being very tough on the Fed, but it's not in Congress' interest to take a big bite out of the Fed's authority.
At CBS MoneyWatch, a reaction to today's release of the advance estimate of 3.2% GDP growth for the first quarter of this year, and to yesterday's news that the four week average for initial claims for unemployment insurance increased slightly:
I explain why I am not as excited by the 3.2 percent growth figure as others seem to be.
At CBS MoneyWatch:
A Loss of Faith in Government, by Mark Thoma: I'm at the Milken Global Conference, my third, and I've been trying to detect changes in the attitude of participants, changes in the program, etc. relative to the past two years now that we've moved from recession to what appears to be the beginning of a recovery.
One of the biggest changes I've noticed, and this goes beyond the conference, is the attitude toward government. Republicans have always targeted government as inefficient, bloated, a threat to liberty, and so on, but this is different. The criticism and contempt for government is more widespread, and it's gone beyond a party slogan. Even with many accomplishments under its belt, e.g. health care legislation, and even with the perception of moving forward on immigration, financial reform, and climate change legislation, government is still viewed as ineffective, irresponsible, and unresponsive to people's needs. ... [...continue...]...
At MoneyWatch, why the 6 percent headline inflation number for producer prices announced this morning does not signal that inflation is imminent, and why core inflation rate of .9 percent is a better measure to look at:
Is the Six Percent Rise in Producer Prices a Signal that Inflation is Coming?, by Mark Thoma: Many news reports are noting the six percent increase in the producer price index on a year over year basis and wondering if it signals that inflation is back. However, this report should not be read as a warning that inflation is just around the corner.
Why? The pass through from producer prices to consumer prices is less than 100 percent in any case, and in some cases it is close to zero. Pass through to consumer prices is smaller when the change in producer prices is temporary, and core inflation measures indicate that most of the rise in producer prices was due to a rise in food and energy prices. Once the temporary changes in food and energy prices are stripped out, the core inflation rate only increased .9 percent over the previous year, and that isn't much different from previous measures.But which measure of inflation should we pay attention to if we want to predict future inflation? Why do we use core inflation instead of "headline" inflation for this purpose?...[...continue reading...]...
I have a roundup of commentary on the SEC fraud allegations against Goldman Sachs at MoneyWatch:
As I noted here, I am swamped today, so I don't have time to say much. But in addition to the summary of the charges and the roundup of commentary (which I will add to later today if more surfaces), I added this:
One of the most significant effects this suit will have from my perspective is how it will change the political atmosphere surrounding financial reform. This will further incite the public against the financial industry -- as it should -- and make it much more difficult for legislators to serve the interests of the financial industry. This will make it harder for legislators to vote against reform in order to protect campaign contributions, or for any other reason. Thus, in addition to what this says about the government's willingness to take on large financial companies, a positive step in and of itself, this should also help to pave the way for needed financial reform.
At MoneyWatch, some comments on the news that the administration is projecting a fall in the deficit:
Note: I added an update to the original post.
What can we learn from Greece:
Learning From Greece, by Paul Krugman, Commentary, NY Times: The debt crisis in Greece is approaching the point of no return. As prospects for a rescue plan seem to be fading, largely thanks to German obduracy, nervous investors have driven interest rates on Greek government bonds sky-high, sharply raising the country’s borrowing costs. This will push Greece even deeper into debt, further undermining confidence. At this point it’s hard to see how the nation can escape from this death spiral...
It’s a terrible story, and clearly an object lesson... But an object lesson in what, exactly? ... The Greek tragedy also illustrates the extreme danger posed by a deflationary monetary policy. And that’s a lesson one hopes American policy makers will take to heart. ...
Greece’s predicament is ... not just a matter of excessive debt. Greece’s public debt,... 113 percent of G.D.P., is indeed high, but other countries have dealt with similar levels of debt without crisis. For example, in 1946, the United States, having just emerged from World War II, had federal debt equal to 122 percent of G.D.P. ... Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half... And debt as a percentage of G.D.P. continued to fall in the decades that followed...
So how did the U.S. ... pay off its wartime debt? Actually, it didn’t.... The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in ... a decade. The rise in G.D.P. in dollar terms was almost equally the result of economic growth and inflation...
Unfortunately, Greece can’t expect a similar performance. Why? Because of the euro..., unlike postwar America, which inflated away part of its debt, Greece will see its debt burden worsened by deflation. ... Deflation ... invariably takes a toll on growth and employment. So Greece won’t grow its way out of debt..., it will have to deal with its debt in the face of an economy that’s stagnant at best.
So the only way Greece could tame its debt problem would be with savage spending cuts and tax increases, measures that would themselves worsen the unemployment rate. No wonder ... bond markets are losing confidence...
What can be done? The hope was that other European countries would strike a deal, guaranteeing Greek debt in return for a commitment to harsh fiscal austerity. That might have worked. But without German support, such a deal won’t happen.
Greece could alleviate some of its problems by leaving the euro, and devaluing. But it’s hard to see how Greece could do that... There are no good answers here...
But what are the lessons for America? Of course, we should be fiscally responsible. What that means, however, is taking on the big long-term issues, above all health costs — not grandstanding and penny-pinching over short-term spending to help a distressed economy.
Equally important, however, we need to steer clear of deflation, or even excessively low inflation. Unlike Greece, we’re not stuck with someone else’s currency. But as Japan has demonstrated, even countries with their own currencies can get stuck in a deflationary trap.
What worries me most about the U.S. situation right now is the rising clamor from inflation hawks, who want the Fed to raise rates (and the federal government to pull back from stimulus) even though employment has barely started to recover. If they get their way, they’ll perpetuate mass unemployment. But that’s not all. America’s public debt will be manageable if we eventually return to vigorous growth and moderate inflation. But if the tight-money people prevail, that won’t happen — and all bets will be off.
At MoneyWatch, my reaction to Federal Reserve Bank of New York President Dudley Calls for the Fed to Take Action Against Bubbles:
[Boarding time -- going here -- guess that's the end of airport blogging for now.]
A reaction to today's ADP report showing the private sector lost 23,000 jobs in March, and what to expect when the BLS issues its employment report on Friday:
I'm worried that distortions in the numbers that make conditions in the labor market look better than they actually are will give legislators the excuse they need to avoid taking up the question of what can be done to help with job creation.
I was supposed to write a tax tip, but I didn't have any so I did this instead:
Mine will be the "one of these things is not like the others" in the set of tips they are assembling.
Note: The post was updated with two graphs from Ezra Klein showing coverage among various groups before and after reform.
I have a quick reaction to the Press Release from today's FOMC meeting at MoneyWatch:
Why are they calling this a jobs bill? There are hardly any job creation measures in it:
Jobless claims bill OK'd by Senate, by Tami Luhby, CNNMoney.com: The Senate on Wednesday approved ... by a 62-36 vote ... the latest job creation effort to go before lawmakers, though it contains virtually no new initiatives to boost employment. Its price tag has wavered between $140 billion and $150 billion, which is partially offset. Its next stop is the House, where a quick passage is anything but assured. ...
Lawmakers have come under pressure from both the White House and unemployed Americans to do more to spur hiring. But after many speeches, officials have enacted little to help the nearly 15 million looking for work. ...
The bill passed Wednesday would push back the deadline to file for extended jobless benefits and the federal subsidy for COBRA health insurance until Dec. 31. ...
The measure would also extend dozens of tax provisions -- including allowing teachers to deduct education expenses and providing businesses a research and development credit -- that expired at the end of last year. ...
It would also temporarily halt a 21% reduction in Medicare physician reimbursement rates. And it would send another $25 billion to the states to help them fund their Medicaid programs for another six months.
The bill also extends two Recovery Act provisions for small businesses. It provides $354 million to continue funding the increased Small Business Administration guarantee and fee waiver through year's end.
Next up is a $15 billion bill that would:
--Exempt employers from Social Security payroll taxes on new hires who were unemployed.
--Fund highway and transit programs through 2010.
--Extend a tax break for business that spend money on capital investments, such as equipment purchases.
--Expand the use of the Build America Bonds program, which helps states and municipalities fund capital construction projects. ...
Even if every measure that has been proposed passes, it won't have much of an impact on jobs. Congress ought to be embarrassed by this effort, it's not even close to what is needed, but come election time, I have no doubt that they'll brag about how they stepped up to the plate in a time of need. What they won't tell you is that they struck out -- looking -- and lost the game.
The administration has not taken full advantage of the opportunity to shape monetary policy during the crisis.
Should the Fed have done more to combat the unemployment problem? In examining the costs and benefits of further easing, I have made almost all of the arguments against further easing by the Fed made below, i.e. that further easing by the Fed may not have much additional effect on long-term real interest rates, that even if rates could be brought down, consumers and businesses would be unlikely to respond by increasing investment and the consumption of durables -- firms already have considerable idle capacity, so why build more, and consumers are pessimistic about their futures, so why buy on credit -- and that there is an inflation risk from further easing.
One additional argument against more aggressive action by the Fed is that there is considerable uncertainty about the effects of further easing because they do not yet have "a robust suite of formal models to reliably calibrate interventions of this sort." But as with climate change, uncertainty does not necessarily translate into inaction. If the uncertainty includes much worse outcomes for employment than expected, and if the costs we attach to that outcome are very large, then uncertainty may prompt more aggressive rather than less aggressive intervention.
Yet another argument concerns the degree to which current productivity changes are permanent of temporary and how that translates into the degree of slack in labor markets. However, on this point I agree that "the sheer magnitude of unemployment today is so large that there is little doubt in my mind that there is considerable slack in the economy." Thus, however this debate comes out, it does not much change the degree and urgency of the unemployment problem.
In the end it comes down to the relative weights placed on the cost of inflation and the cost of unemployment, and I don't think policymakers are placing enough weight on the unemployment term (particularly given the uncertainty about the speed of recovery).
The Fed has the ability to help -- something needs to be done -- and a responsibility to help to the unemployed. The Fed is not alone in not doing enough, fiscal policymakers bear even more responsibility for failing to act aggressively, but that doesn't excuse the Fed's less than full bore attack on the unemployment problem.
This is the last part of a speech given today from Charlie Evans, President of the Chicago Fed, along with a graph from the speech showing the severity of the long-term unemployment problem:
Labor Markets and Monetary Policy, by Charles Evans, President, Chicago Fed: ...Productivity and resource slack The other side of an economy experiencing growing output but low labor utilization is high productivity growth. Indeed, productivity has been quite strong of late, particularly over the past three quarters. This is often the case in the early stages of a recovery, as firms first meet higher demand for their products and services without expanding their work force.
A key question today is the degree to which the recent productivity surge reflects a temporary cyclical development or a more enduring increase in the level or trend rate of productivity. If the gains are predominantly driven by intense cost cutting, then they may be unsustainable once demand revives more persistently. In this case, we would expect hiring to pick up quickly as the economic expansion takes hold. However, if the level or trend in productivity has risen due to technological or other improvements, then higher average productivity gains will continue. In this case, the implications for hiring are not clear. Higher levels of productivity will show through in both higher potential and actual output for the economy, and so need not necessarily come at the cost of lower labor input.
The relative importance of these factors also has consequences for our assessment of the degree to which resource slack exists in the economy. Since a higher level or trend of productivity implies a higher path for potential output, a given level of actual GDP would also be associated with a greater degree of economic slack. That is, the good news on productivity, if sustained, suggests that as of today we have a larger output gap to fill In contrast, some are skeptical that the economy really is operating far below sustainable levels. They argue that much of the drop in output during the recession was the result of a permanent reduction in the economy’s productive capacity, perhaps because certain financial market practices that had for a time enabled additional investments have now been discredited. According to this view, the strong productivity growth of recent quarters only goes a fraction of the way toward offsetting this decline in the level of potential output.
Of course, the unemployment rate gives us another way to infer the degree of slack in the economy. My earlier discussion of the sharp rise in unemployment duration and decline in labor force attachment may lead one to think that slack is even greater than what is implied by the unemployment rate itself.
However, it is possible that longer durations and lower labor force attachment could reflect broader structural changes in the economy, such as a mismatch between the skills of the unemployed and those demanded by employers. There may also be other impediments that currently prevent workers from shifting to the industries or locations where jobs are available. Under these scenarios, labor market slack might actually be lower than what one might infer from the unemployment rate alone.
I have just given you 2 minutes of classic two-handed economist speak. In the final analysis, however, the sheer magnitude of unemployment today is so large that there is little doubt in my mind that there is considerable slack in the economy. Incorporating alternative views about productivity and labor market behavior do not alter this general conclusion. The debate really boils down to whether the amount of slack in the economy is large or is extremely large.
Should the Fed have done more?
Given this large degree of slack, there is a legitimate question of whether monetary policy could, and more fundamentally should, have done more to combat the deterioration in labor markets. As we all know, a lot was done. As the crisis arose, we first used our traditional tools, substantially cutting the federal funds rate and lending to banks through our discount window. As we neared a zero funds rate, we turned to nontraditional tools to clear up the choke points, providing liquidity directly to nonbank financial institutions and supporting a number of short-term credit markets. Finally, we reduced long-term interest rates further by purchasing additional medium- and long-term Treasury bonds, mortgage-backed securities, and the debt of government-sponsored enterprises.
These nontraditional actions helped us avoid what easily could have been an even more severe economic contraction. But the unemployment rate still hit 10 percent this fall.
Had we done more, the most plausible action would have been to expand our Large Scale Asset Purchases (LSAP) program. Precisely quantifying the effect this would have had is difficult. A good place to start, though, is to look at the recent empirical evidence. When significant new asset purchases were announced, our big, fluid financial markets built that information immediately into asset prices. For example, right after the March 2009 Treasury purchase announcement, ten-year Treasury yields fell about 50 basis points. Comparable declines occurred in Option Adjusted Spreads (OAS) on the announcement of agency mortgage-backed securities (MBS) purchases in November 2008. It might be reasonable to infer that say, doubling the size of the LSAPs might have doubled this impact on rates.
However, I would attach more than the usual amount of uncertainty to such an inference. Part of my hesitation reflects our lack of understanding about the interactions between nontraditional monetary policy, interest rates, and economic activity. While research efforts at the Federal Reserve and elsewhere to assess the effects of nonstandard monetary policy have been ramped up considerably, to date we do not have a robust suite of formal models to reliably calibrate interventions of this sort.
Moreover, there are reasons to expect that the impact of recent nontraditional policy actions might not have scaled up so simply. We initially responded to the financial crisis with our highest-value tool—a reduction in the funds rate—and then moved to our best alternative policies as interest rates approached zero. Finally, we turned to the LSAPs, which were designed to further lower long-term interest rates and thus stimulate demand for interest-sensitive spending, such as business fixed investment, housing, and durables goods expenditures. But the influence of lower rates on private sector decision-making may have reached the point of second-order importance relative to the countervailing forces of the housing overhang, business and household caution, and considerably tighter lending standards.
Moreover, although it is impossible to quantify, a portion of the impact of our nontraditional actions may have come simply from boosting confidence. In those very dark times, I believe households, businesses, and financial markets were reassured that policymakers were acting in a decisive manner. Further asset purchases would not have had an additional effect of this kind.
In addition, on a practical level, the portfolio of future purchases likely would have looked different and therefore their overall effectiveness might have deviated from our recent experience. The Fed’s typical monthly purchases of new issuance MBS were so large that it left very little floating supply for private investors. This could have forced a larger LSAP program to concentrate more heavily in Treasuries or existing MBS. Though the empirical evidence is limited, these assets likely are less close substitutes than new MBS for many of the instruments used to finance spending on new capital goods, housing, and consumer durables. Consequently, the effect of their purchase on economic activity may be less.
Finally, we must also keep in mind that more monetary stimulus also has costs. These could be considerable at higher LSAP levels. Many are already worried about the inflation implications of the Fed’s expanded balance sheet and the associated large increase in the monetary base. Currently, most of the increase in the monetary base is sitting idly in bank reserves—and because banks are not lending those reserves, they are not generating spending pressure. But leaving the current highly accommodative monetary policy in place for too long would eventually fuel inflationary pressures. Likewise, if the monetary base was expanded much beyond where we are today, the risk that such pressures would build as the economy recovers would be significantly increased. Furthermore, policymakers already face the task of unwinding a sizable balance sheet at the appropriate time and pace. Substantially increasing the size of asset purchases could have further complicated the exit process down the road.
That said, changes in economic conditions could alter the cost–benefit calculus with regard to the LSAP. Hopefully the recovery will progress without any serious bumps in the road and the inflation outlook will remain benign. But, as we have repeatedly indicated in the FOMC statements, the Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets. ...
The employment report is essentially unchanged from last month with unemployment holding steady at 9.7%. Here are some discussions of the report.
There is a lot of optimism about this report due to the fact that it appears that the rate of deterioration in labor markets is slowing and perhaps even about to turn the corner. But I find it hard to be upbeat about an economy that is moving sideways, especially when the broad measure of unemployment increased, and hours worked fell.
It's good to see that the administration recognizes this. Brad DeLong:
Statement on the Employment Situation in February: [A]n unemployment rate of 9.7 percent is unacceptably high and we need to achieve robust employment growth in order to recover from the terrible job losses that began over two years ago. That is why it is essential that Congress pass additional responsible measures to promote job creation. It is also vital that we continue to support those struggling with unemployment...
Such as? What responsible measures?
The biggest and easiest would be another $300 billion in aid to states for the remainder of fiscal 2010 and 2011 to keep state and local services from suffering additional cuts and to shave perhaps 1.5 percentage points off the unemployment rate. Senators, however, are opposed to it: if they give money to governors, governors use them to cut ribbons and then run against senators to try to take their jbos. It would, however, be the right thing to do.
I expect Congress will implment a few token employment measures they can brag about in reeloection speeches, but I don't expect anything anywhere near the amount needed to be enacted. [Also posted at MoneyWatch.]
I have a discussion of today's release of data on claims for unemployment insurance at MoneyWatch:
Many are hailing this report as good news, but I have a different view of what the numbers say.
At MoneyWatch, I explain why Senator Kyl is wrong when he asserts that unemployment compensation cannot create jobs:
[And don't forget about The Importance of Automatic Stabilizers such as unemployment compensation.]
In a recent MoneyWatch post I said:
The release last Thursday of initial weekly claims for unemployment insurance showing 473,000 claims, an increase of 31,000 over the 442,000 claims the previous week, hasn't received nearly enough attention. Claims have been essentially moving sideways for several weeks now, and they are still far above the break even point at approximately 400,000 claims per week. The economy will continue losing jobs so long as initial claims stay above 400,000 per week. ...
Claims will be released on Thursday of this week, and I'll be keeping a closer eye on them than usual. If they continue to move sideways, it's time to worry.
I'd be less worried if it looked like a meaningful job creation package was about to emerge from Congress, but the proposals under discussion don't do nearly enough, and what little that has been proposed isn't happening as fast as needed. ... And while it's good that health care reform is coming back onto the front burner, that means that a job creation bill is unlikely to be the main priority for Congress in the near future.
Update: Maybe they were listening. If this bill does eventually pass, it will still be far, far short of what is needed, and much later than needed, but it's something. A meager something, but something nonetheless.
Here is Calculated Risk on today's release:
The DOL reports on weekly unemployment insurance claims:
In the week ending Feb. 20, the advance figure for seasonally adjusted initial claims was 496,000, an increase of 22,000 from the previous week's revised figure of 474,000. The 4-week moving average was 473,750, an increase of 6,000 from the previous week's revised average of 467,750. ...
This graph shows the 4-week moving average of weekly claims since 1971. ...
The current level of 496,000 (and 4-week average of 473,750) are very high and suggest continuing job losses in February. This is the highest level since last November.
Action from Congress to stimulate jobs has been woefully inadequate. Voters will be right to blame politicians for failing to address this problem. Policymakers certainly had plenty of warning it was coming, but they chose to put their heads in the sand and ignore it, or to avoid the difficult politics of job creation policies by cherry picking the data in a way that convinced them that recovery was just around the corner.
[Also posted at MoneyWatch.]
I posted this at MoneyWatch:
Health Care Reform: The Obama Compromise Proposal and the Likely Republican Response, by Mark Thoma: A discussion of the options for health care reform Democrats have before them, and the counter-proposals that Republicans are likely to offer. Many Republicans will oppose reform with little motivation beyond handing Democrats a loss, but some will be willing to offer their own ideas as counter-proposals to the administration's reform plan. Are the counter-proposals worth pursuing?
At MoneyWatch, I argue that unless Congress can learn to walk and chew gum at the same time, which it's unlikely to do, a side effect of the renewed attention to health care reform may be less job creation and higher unemployment:
Update: Maybe they were listening. If this bill does eventually pass, it will still be far, far short of what is needed, and much later than needed, but it's something. A meager something, but something nonetheless.
At my blog at CBS MoneyWatch:
Given the importance of automatic stabilizers, why hasn't more attention been focused on how well our present set of automatic stabilizers has fared in this recession, and how we might do better?:
Did the Fed Cause the Recession?, by Mark Thoma: I have been more defensive of the Fed's actions both before and after the crisis started than most, and I want to talk about why recent criticism of Bernanke and the Fed for their failure to use regulatory intervention to stop the housing bubble is correct, but perhaps directed at the wrong target. ...[...continue reading...]...
At CBS MoneyWatch, why I haven't joined the loud calls for the Fed to engage in quantitative easing as a means of creating jobs:
The Fed Can Help, But Fiscal Policy Is The Key To Job Creation, by Mark Thoma: There are many people currently criticizing the Fed for worrying too much about inflation and not enough about employment. They want the Fed to use quantitative easing - the purchase of financial assets when interest rates are already at zero - as a means of stimulating the economy and creating jobs. I think it's a mistake ...[...continue reading...]...
At MoneyWatch, some of the pressures the Fed might come under in the future if the government debt continues to rise, and the important role that Fed independence plays in making sure that the debt is not inflated away:
Budget Deficits, Fed Independence, and Inflation, by Mark Thoma: I have been critical of both Alan Greenspan and Ben Bernanke for giving recommendations concerning fiscal policy during their testimony before congress. In Greenspan's case, it was his comments about tax cuts that I found problematic, while for Bernanke it was his comments on entitlements.
But monetary and fiscal policy are connected, and the Fed chair should talk about the impact that a growing debt level might have monetary policy. That is, while I don't think the Fed chair should give advice on the specifics of fiscal policy, the chair should make clear how fiscal policy choices will affect or constrain monetary policy. ...[...continue...]...
What’s Wrong With the Dodd Proposal to Restructure the Fed, by Mark Thoma: A proposal from Senate Banking Committee Chairman Christopher Dodd changes the selection process for key positions within the Federal Reserve system. Unfortunately, this proposal makes the selection process worse, not better. If this proposal is passed into law, it would further concentrate power within the Federal reserve system and politicize the selection process, both of which are the opposite of the where reform should take the system. ...[...continue reading...]...
I just posted this at MoneyWatch:
Housing starts fell unexpectedly last month. The Census report gives the details:
Privately-owned housing starts in October were at a seasonally adjusted annual rate of 529,000. This is 10.6 percent (±8.7%) below the revised September estimate of 592,000 and is 30.7 percent (±8.3%) below the October 2008 rate of 763,000.
Single-family housing starts in October were at a rate of 476,000; this is 6.8 percent (±7.5%)* below the revised September figure of 511,000. The October rate for units in buildings with five units or more was 48,000.
This graph shows the recent trend in housing starts:
As the graph shows, starts bottomed several months ago, and have been "moving sideways" ever since. What is causing housing starts to move sideways rather than recover? Calculated Risk, one of the best sites for analysis of the housing industry, gives this explanation (which I agree with):
Total housing starts were at ... the all time record low in April of 479 thousand (the lowest level since the Census Bureau began tracking housing starts in 1959). Starts had rebounded to 590 thousand in June, and have move sideways (or down) for five months.
Single-family starts were at 476 thousand (SAAR) in October... Just like for total starts, single-family starts have been at this level for five months.
As he notes, an important piece of the puzzle is that the percentage of vacant units has been climbing and is now at a record level (see this report):
It is very unlikely that there will be a strong rebound in housing starts with a record number of vacant housing units.
The vacancy rate has continued to climb even after housing starts fell off a cliff. Initially this was because of a significant number of completions. Also some hidden inventory (like some 2nd homes) have become available for sale or for rent, and lately some households have probably doubled up because of tough economic times.
It appears that ... starts are now moving sideways - and will probably stay near this level until the excess existing home inventory is reduced.
This raises the question of whether the overall economy will echo this pattern of falling backwards after apparent improvement, i.e. of moving sideways for a period of time. This is something I don't think we can or should rule out as we think about the appropriate economic policies that we should have in place to help the economy recover from the recession.