So that San Francisco Fed says that the natural rate of unemployment may have risen to nearly 7%.
Mounting evidence suggests that structural factors may have increased the “normal” rate of unemployment to about 6.7%. Much of this increase is likely to be temporary. In particular, the extension of unemployment benefits probably accounts for about half of the increase. But, even with a 6.7% natural rate, current and forecasted levels of unemployment imply that significant labor market slack will persist for several years.
Its important to remember that monetary policy itself can influence the natural rate.
When we look at the history of Eurosclerosis, the tendency of many European countries to have stubbornly high unemployment despite growing economies, we see that those nations most aggressive in bringing down inflation had the worse cases of sclerosis. More importantly, countries which reversed tight money policies in the face of severe unemployment saw the natural rate of unemployment fall.
Laurence Ball does a nice review.
Another way of saying all of this: Recession are caused by money, either a change in the demand for it or the supply of it. This is not to say fiscal policy plays no role but simply that unemployment rises sharply when people cannot build a cushion of savings as fast as they would like to. Broad based tax cuts for example, could allow people to build up their savings faster than they would otherwise.
However, once going, unemployment can beget unemployment as people who haven’t had a job in a while are less employable. One of the things we notice even from recessions of old is that unemployment rises faster than it falls.
This suggests that getting a job is not simply the inverse of losing one. The labor force is changed by mass layoffs. That change has to be undone.
What does all of that mean?
It means that we shouldn’t be inclined to “settle” for an unemployment rate of 7% or see that as the new target. Sustained aggressive monetary policy will bring the natural rate down over time. We should be aiming to “shoot past” 7%, knowing that the new target will be lower than 7% by the time we get there.
As a side note, I am unsure how to approach the hard money folks, who at the moment I see as the greatest immediate impediment to the health of the nation. On the one hand we can make the very true case that inflation is nothing to be worried about now. The Fed can continue to press forward without fear of rising much above its presumed target of a 2% core rate, anytime soon.
My fear is that this doesn’t address the long run issue, that we may need to go above that comfort zone to undo some of the damage of this recession. That kind of talk gets a lot of people nervous and may even hurt efforts at current monetary expansion.
Yet, resorting to the “but inflation is low now” position almost concedes that any inflation rate higher than 2% is indeed undesirable. That is not what I mean at all.