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Here is a word cloud of words used by Bernanke during the press conference which was held today:


[Click Image to Enlarge]

As you notice, inflation was mentioned quite a bit, which, really, is something that you should expect from a QA with a monetary policymaker. Many are lamenting the fact that unemployment took a back seat, and Reuter’s itself challenges us to find the word “jobs” in the word cloud. Personally, I enjoyed the fact that Bernanke basically said jobs are someone else’s policy purview — which I view as the right response. However, the fact remains that monetary policy is not on target, and that is a problem for Bernanke. A bigger problem may be that 2% inflation isn’t a target at all! Could the US be following Japan’s lead into self-induced paralysis?

In any case, here is the question (and rest of the e-mail, references removed) that I sent to be asked, which did not get asked:

First, thank you for sending me your e-mail address. I’m tepidly excited about Bernanke’s press conference tomorrow…but I have a lot of reservations. You could probably call me old-fashioned, but I’m always leery of public policy “rock stars”, like the “Committee to Save the World”, and Ben Bernanke being “Man of the Year”. In any case, I think there is going to be a strong focus on grilling Bernanke on employment levels (I see that David Leonhardt wrote a column urging that to be so). I view this as very counter-productive.

But I did tweet you my question, which was this:

“As recently as 2003, Bernanke [You] championed price level targeting as a remedy for the ‘liquidty trap’. Many other economists also endorse this idea. Given the failure of monetary policy in preventing a sharp fall in GDP in Oct 2008 w/ inflation targeting, what are your thoughts on NGDP lvl targeting? Implementation challenges? Benefits or costs that you see?”

I wanted to provide some background for this question, because it can seem like it is kind of out of left-field, given a “mainstream” interpretation of events. As you may know, many prominent economists (Krugman, DeLong, Blanchard) have publicly advocated an explicit inflation of greater than 2%. A subset of this work was done by Lars Svensson[1] and Ben Bernanke himself[2], only instead of using inflation targeting, both economists have advocated setting an explict price level target in order to escape the “liquidity trap”. Another strain of this work that has been popularized recently by Scott Sumner, David Beckworth, Marcus Nunes, Josh Hendricksen, and myself, (among others!) involves monetary policy targeting nominal cash expenditures in the economy, or NGDP. More “academically”, Robert Hetzel[3] and Michael Belognia[4] have advocated that cash grow at a steady pace.

A common theme among those who push the “NGDP level targeting” view and others is that we tend to believe that causality in this recession runs (roughly) this course: mild supply shock (subprime) > tight money (Jun – Nov 2008) > large crash (Oct 2008) > inadequate Fed accommodation (2009/2010) > sluggish and “jobless” recovery. Indeed, even Christina Romer seems to be on board with something like this interpretation[5]. In my opinion, the Fed should target like a laser on the long-run growth path of NGDP, and keep it growing on a stable path (5% was the trend of the Great Moderation, but some economists advocate a transition to 3% nominal growth), making up for slack and overshooting when it happens by loosening or tightening money (respectively) such that the market forecast and the Fed’s forecast are basically one-in-the-same. This leaves little room for paying much attention to the level or rate of employment in the economy. The only time that should concern the Fed is if there is a large enough structural change that they should revise their NGDP target based on a sustainable increase (or decrease) in productivity (be it labor, capital, or TFP).

As an aside, David Beckworth has urged the Fed to target the cause of macroeconomic instability, and not symptoms of it[6]. Unemployment is one symptom, as is inflation/disinflation/deflation. From this perspective, NGDP level targeting is far superior to price level (and inflation) targeting.

I hope that gave you a brief (but adequate) overview to acquaint yourself with the NGDP level targeting position if you were unfamiliar, so you’re not shooting in the dark. I know you probably won’t get to the references. As a tactical request, if you see it fit to use my question, I’d work hard to get an answer out of Bernanke regarding NGDP targeting rather than price level targeting. The reason I bring this up is that if you mention “price level targeting” in the question, while you make the question more likely to get answered (price level targeting is more mainstream), you also give Bernanke an out in that he can simply muse about price level targeting and avoid the NGDP targeting question altogether, even though they’re different concepts. It’s a tricky pole to balance.

Thanks for allowing me to participate!

Niklas Blanchard

http://www.modeledbehavior.com

[1] http://papers.ssrn.com/
[2] http://www.federalreserve.gov/ and http://people.su.se/
[3] http://www.richmondfed.org
[4] http://mpra.ub.uni-muenchen.de/
[5] http://emlab.berkeley.edu/
[6] http://macromarketmusings.blogspot.com/ and http://macromarketmusings.blogspot.com/

Sadly, there were no intrepid reporters in the audience venturing these grounds.

[h/t Paul Krugman]

Jim Hamilton has a nice breakdown on all the positive signs for US growth. I even have a new presentation I am giving titled “Don’t Be Lulled into Fall Sense of Despair” that basically argues that if things go as planned the US economy will be growing steadily and so will profits and tax revenues.

All that having been said my worry is that this will cause the Fed to back off of its aggressive stimulus policy. The Fed should stay the course with QE2 and consider QE3.

As I have mentioned before, we are conditioned to think of 3 – 4% growth as strong. However, that is in a world where there are few slack resources. This is not our world. Our world has plenty of idle resources.

6% growth is not unrealistic. I urge the Fed to push towards that goal. High profits and growing government revenues are great but we need to put people back to work.

The Mankiw Rule for example doesn’t call for raising the funds rate above zero until the (unemployment rate – core inflation) rate drops below 6. Right now we are still above 7.5

FRED Graph

Indeed here is what the Mankiw Rule says the Fed Funds rate should be

FRED Graph

We are still deep into negative territory meaning that we need additional monetary stimulus above and beyond a zero interest rate.

As a side note, I would love to claim that QE2 is behind this increased growth but that is premature. The timing is right on, but we need more evidence before we can claim intellectual victory.

Via The Daily Dish, I see Austin Frakt has some interesting thoughts about how unemployment insurance may be decreasing migration:

I wonder to what extent UI benefits discourage migration. North Dakota could use some workers. Nevada has too few jobs. Yet we’re paying people in Nevada whether they have a job or not. I doubt many would move to North Dakota anyway. Paying them not to makes it less likely. But how much less likely?

This reminds me of something I proposed awhile ago, which is to let the unemployed front-load their unemployment insurance if they use it to move. Here is what I wrote:

So what policies could we pass to make the unemployed better off and incentive them in a way that speeds up the structural unemployment adjustment process?

One idea is relocation vouchers. If you offer relocation vouchers to unemployed workers who move a minimum distance from their current residence, then you could incentivize labor to move where it is needed away from where it is no longer needed.

The demand for this type of voucher can be seen in the piece from Catherine Rampell on structural unemployemt that Avent was commenting on…

This is someone who could clearly be made better of by a moving voucher. In contrast, unemployment payments for her would do nothing to incentivize or even allow her to move, which would mean she remains in the labor market for which her skills are not needed at a salary she will accept.

One way to pay for this program would be to allow workers to front load their unemployment. Take a full three months worth of unemployment at once instead of spreading it out as long as the person can verify that they are relocating a minimum number of miles away from their current residence.

Obviously there are some problems with this. How do you ensure that movers weren’t going to move anyway? How to you monitor whether they are actually moving or if they are just going on vacation? Still, I think it’s worth consideration, as more labor mobility would do the economy good right now.

There are two important questions in the economy today that may be related: 1) is negative equity causing a decrease in geographic mobility? and 2) why is the Beveridge Curve breaking down? Wait! Don’t stop reading yet, I can explain it in non-econo-jargon, I promise.

House prices have obviously fallen a lot since the peak of the bubble, and this has left many homeowners “underwater”, so to speak, meaning they owe more on their mortgages than their house is worth. This is potentially causing a big decrease in people’s willingness to move, which includes moving for a job. This, in turn, is potentially causing higher unemployment by preventing people from moving away from places where their labor isn’t demanded to places where it is. The question is, how big of a deal is this?

The second question relates to the Beveridge Curve, which shows the relationship between the unemployment rate and the number of job vacancies. The idea is that when unemployment is high, job vacancies should be low, and vice versa. If people are having a hard time finding work, then employers shouldn’t be having a hard time finding workers, since there are plenty of unemployed people looking for work. However, as the graph below shows this relationship has broken down somewhat over the recent recession. This is suggestive of some sort of friction in the labor markets that is preventing employers from finding hires among the vast numbers of unemployed.

A recent study investigates whether house price induced immobility is causing the breakdown in the Beveridge Curve. This is an intuitive and plausible mechanism.  House prices fall, homeowners are underwater and can’t move to jobs, so there are unemployed people in one area and job vacancies in another, and negative equity prevents them from moving to those jobs. Supporting their hypothesis, the authors cite a 2010 study by Ferreira, Gyourko and Tracy which found that having negative equity reduced the probability that a homeowner would move by 35%.

The study uses a structural VAR (which is a big regression with multiple dependent variables) to estimate the dynamic relationship between 3 housing market variables and 2 labor market variables. They find that their model predicts 30% of the increase in unemployment observed during the great recession, and in generates a flat or slightly upward sloping Beveridge Curve as observed in reality. The authors are then able to run a counterfactual where they removing shocks to housing preferences, meaning that they see what would have happened to unemployment without the housing bubble.  They find that the unemployment rates are in line with the Beveridge Curve, and thus conclude that underwater homeowners can explain the breakdown of the Beveridge Curve. The graphs below show the counterfactual unemployment rates in two scenarios: a high leverage economy, and a low leverage economy.

The authors do caution that their model is a simple one, but the results suggest that housing markets are holding back labor markets. What is also important to note however, is that the model only explains 30% of the increase in unemployment during the Great Recession, leaving plenty of room for aggregate demand led unemployment.

I was going to write up a post on my exasperation at the Fed’s recent meeting statement, but Ezra Klein got to it before me and did a good job, so you should go read what he has to say. One point that I want to highlight, because I have made the point that the dual mandate is mostly just an insiders joke:

Paragraph two: We admit everything is terrible. In fact, it’s so terrible that it means we’re failing our mandate. “Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.”


[Image Courtesy of David Beckworth]

How many of you wish that you had a job where you could consistently fail at the very time when it is clutch that you deliver in a big way? How many of you would like to say, “Well, I have a model of the economy that says we won’t be hitting any of our own targets…but oh well”? The Federal Reserve is in the exact position in the economy where they can act quickly and decisively and actually make a large impact on nominal spending. I would even go as far as to say that they can do so without “long and variable lags”, as markets should price in actions by the Fed nearly immediately, and indeed they have been.

Contrary to the popular narrative, I believe that it is this very passivity by the Fed that brought us to the brink in the fall of 2008, when every indicator of economic activity (industrial output, consumer spending, business confidence, NGDP expectations, etc.) were found to be in sudden free-fall mode. At that time, interest rates were in the 1.5%-2% range, and the Fed’s target was still 2% until October 2008!

And here we are, fully two years later, and we still cannot get the Fed to act…nor can we get the executive branch of government to take the problem seriously! This inaction belies an institution that either is ill-equipped to respond when necessary, or is structured in a way that prevents decisive action. Since I believe that the Fed has all the tools it needs (it being a monetary superpower), I would place the blame on the structure of the network.

There is nothing more important on the Fed’s plate right now than bringing nominal spending back in line with the previous trajectory of NGDP. Not only to assist 50 million people who are currently unemployed, and help numerous others rebuild their balance sheets…but to save our economy from the whims of populist sentiment that will likely take hold if our economic malaise continues for very much longer. That means rounds and rounds of fiscal stimulus. That means the development of an entire class of freeters who never reach full potential. And most importantly, that means the loss of real goods and services that could otherwise be produced in our economy — which translates into a lower real standard of living for everyone.

At this point I would do anything for a little more monetary stimulus.

There has been a lot of chatter around the blogosphere about Narayana Kocherlakota’s speech in Michigan last week, and seeing as I am trying to catch up on news, I think that is a good a place as any to start. First, here is the whole speech, so that you can read it if you would like.

The big focus, especially among left-leaning commentators, has of course been Kocherlakota’s comments on the unemployment situation. The only troubling thing to me about a monetary policymaking body discussing unemployment is the fact that it is happening at all. I don’t believe that there is anything “special” that monetary policy can do to alleviate unemployment — even in a booming economy. The capacity of monetary policy to act is to keep nominal GDP growing at a constant rate, year over year, and to tighten a little when it overshoots and loosen a little when it undershoots — such that the trend path of NGDP is a constant upward slope. I’m not an expert on the welfare-maximizing trend rate of NGDP…but people who are much smarter than me on average advocate 5% NGDP growth.

In any case, in the speech, Kocherlakota breaks down how Fed meetings operate, and then breaks down his “forecast speech” that he gave to the FOMC. Along those lines, he has three points: GDP (real), inflation, and unemployment. On those three points, he has this to say:

Typically, real GDP per person grows between 1.5 and 2 percent per year. If the economy had actually grown at that rate over the past two and a half years, we would have between 7 and 8.2 percent more output per person than we do right now. My forecast is such that we will not make up that 7-8.2 percent lost output anytime soon.

[…]

The Fed’s price stability mandate is generally interpreted as maintaining an inflation rate of 2 percent, and 1 percent inflation is often considered to be too low relative to this stricture. I expect it to remain at about this level during the rest of this year. However, our Minneapolis forecasting model predicts that it will rise back into the more desirable 1.5-2 percent range in 2011.[1]

[…]

Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers. […] Given the structural problems in the labor market, I do not expect unemployment to decline rapidly. My own prediction is that unemployment will remain above 8 percent into 2012.

[1]5yr TIPS spread is at 1.43, 10yr @ 1.55.

Now, not making up the lost employment is partially a function of his previous point about per capita GDP remaining under trend for an extended period of time. This is the cyclical component of unemployment. Cyclical unemployment is created due to the relationship of the economy to the cycle of time. As such, the level of cyclical unemployment correlates well with the business cycle, seasonal factors, etc. I believe that most of the unemployment we are currently experiencing is of cyclical nature.

I think the error in Kocherlakota’s thinking stems from this quote:

Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

This is wildly baffling. Not only does Kocherlakota make the forecast above — i.e. we will not be hitting any of our targets (nominal or otherwise) any time soon — he also states that he believes that money has been easy. That implies that monetary policy has zero effect on the economy, any time. He also identifies that low rates for an extended period of time are a sign of monetary failure, but does so in a future-orientation. While it is true that low rates can (and do) accompany* a deflationary “trap”, the policy prescription that follows is not to raise short-term rates regardless of the composition of employment. The proper policy response in that situation is to set a positive nominal target, level targeting and commit to move heaven and earth to hit that target.

That, rather than his statements about unemployment, is what I view as Kocherlakota’s underlying problem.


*H/T to Andy Harless in the comments. Also, read his post about Kocherlakota’s statements.

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