The Job News is Not Good

As you are probably aware, job creation fell last month and we actually lost 4,000 jobs, on net, for the first time in several years.

I haven't done much forecasting here, I'm too optimistic and get too invested in my own calls when I do, and I find myself tending to interpret incoming data in ways that support the call. So I mostly avoid calling the economy. It's not a game you can win very often, and I don't devote enough time to looking at all the underlying data to really get a good sense of, say, what employment in this or that industry is doing this month, etc.

So I will leave forecasting to others, Tim does it here, but it's hard to interpret today's report and recent trends in job creation positively. Those who do make forecasts, some of whom have been calling a recession for a year or more - several years in a couple of cases - may finally see their forecasts validated and be able to pat themselves on the back, but I still find myself hoping that somehow this will work itself out and the workers who have lost their jobs will get reabsorbed quickly into equivalent employment in other sectors.

For the supply-side types who support tax cuts because they promote economic growth by reducing economic distortions, I guess it's time to start writing the inevitable "think how bad things would have been without the tax cuts" columns. But as you are writing and find yourself tempted to call for further tax cuts to avoid a recession, remember that using tax policy to stimulate the economy and reduce the severity of downturns is Keynesian economics, not supply-side policy, something that many of you have confused in the past. I am not at all opposed to interventions to stabilize the economy, though tax policy is just one of many options (and who gets the tax cuts matters as well), but let's not pretend that using tax policy to stimulate the economy is faithful to supply-side ideals.

I'm short on time for the moment, so to fill the void here's something I wrote a little over two years ago on this general topic [edited]:

The Insurance Value of Increasing the Federal Funds Rate: ...The extraordinarily low interest rates brought about a sectoral imbalance in the economy. In models with sluggish prices and wages, it is the change in relative prices brought about by the accommodative money that causes the imbalance. We hear stories about the imbalance all the time, the high number of workers in housing construction, the rising number of realtors, all of the secondary jobs, and so on. It seems very clear that a relative price distortion between sectors brought about by low interest rates has led to an economy that is very unbalanced towards interest sensitive sectors such as housing, and there is a lot of concern about our vulnerability due to that imbalance. If the imbalance was caused by low interest rates, then the solution is to raise interest rates to take away the incentive that caused the imbalance to begin with. Until the incentive that caused the imbalance is removed, until rates are raised, the imbalance and the vulnerabilities that come with it will remain.

Paying the fiddler is always painful. If we intentionally unbalance the economy to attenuate a recession, then much like Keynesian policy of running a surplus in good times to pay for the deficits used to stimulate the economy in bad times, rising interest rates and slower economic growth are the costs that must be paid to attain a healthier more balanced economy during the recovery period. But it's always tempting to avoid such costs.

Think of the housing sector as a balloon with too much air, a balloon ready to pop if subjected to additional stress. The chance of the balloon bursting is reduced if we let the air out very slowly and carefully. Thinking further of the escaping air as resources flowing out of the housing sector, we shouldn't allow the air escape, but instead use it to re-inflate balloons representing other sectors of the economy, hopefully sectors that could use the infusion of resources. There are lots of policies that can be implemented to facilitate this structural change outside of monetary policy, policies that allow as little air to escape as possible during the sectoral rebalancing, and those ought to be pursued vigorously.

I believe that getting the air out of the balloon at a slow, measured pace so as to re-inflate other sectors, with everybody warned that it is happening so that if the balloon pops loudly nobody jumps out of their seat, is best for now. This will require raising the federal funds rate. I want labor and other resource and output markets to be as robust as possible against shocks when the next one hits, and one will hit someday, and rebalancing the economy is an essential insurance policy against such risks. Slower output growth during the rebalancing period is the cost of the insurance premium for labor and I understand that some feel the insurance is far too expensive. For now, I do not.

We did raise rates, but it appears that resources may not have moved out of housing fast enough to avoid a "pop". We shall see.