Today’s disappointing employment report demonstrates the stark reality facing U.S. policy makers: If they want to create more jobs, they will have to find a way to generate more economic growth.
The Labor Department reported that U.S. nonfarm payrolls grew by 115,000 in April, bringing the three-month average increase to 176,000. That’s down from a three-month average of 252,000 in February. It’s also just barely enough to reduce the unemployment rate, which inched down to 8.1 percent in April from 8.2 percent in March as the number of people looking for work declined.
The weakening trend confirms a fundamental tenet of economics: It takes better-than-average momentum to achieve a significant decline in unemployment. According to a rule of thumb known as Okun’s Law -- named after Arthur Okun, an economic adviser to presidents John F. Kennedy and Lyndon B. Johnson -- growth must exceed its long-term potential rate by two percentage points to lower unemployment by one percentage point.
For a while, the labor market seemed to be defying this rule of thumb. The jobless rate fell 0.9 percentage point in 2011, even though the economy grew at an inflation-adjusted rate of only 1.7 percent, well below the 2 percent to 3 percent that most economists believe to be its long-term potential.
Now, though, that surprising burst is looking more like a temporary catch-up after the lackluster job growth of the early part of the recovery. The trajectory of the employment-to- population ratio in the three months through April suggests no actual progress in reducing unemployment. This is more in line with economists’ average forecast of 2.3 percent output growth this year, and with their expectation that the jobless rate will still be well above 7 percent at the end of 2014.
How, then, can U.S. policy makers improve the jobs picture? The obvious answer is more growth through fiscal stimulus. Research shows that added government spending tends to be particularly effective at times like these, when interest rates are extremely low and long-term unemployment is threatening to do permanent damage. The growth boost could actually reduce the U.S. government’s debt burden.
Unfortunately, Congress seems likely to do precisely the opposite. Economists at Goldman Sachs Group Inc. estimate that the waning of government stimulus, together with spending cuts already enacted, will shave about 1.5 percentage points off economic growth in 2013. If politicians can’t agree on a way to extend some of the Bush tax cuts beyond the end of this year and to postpone the automatic spending reductions dictated by last year’s debt-ceiling deal, the negative effect could be many times larger.
The political gridlock leaves the Federal Reserve as the only entity capable of providing stimulus. Its ammunition isn’t nearly as powerful as the government’s: A third round of quantitative easing, in which the Fed would buy bonds to bring down longer-term interest rates, would almost certainly be less effective than its two predecessors. Goldman Sachs estimates that an added $1 trillion of Fed purchases might boost economic growth by 0.5 percentage point in the first year after a QE3 announcement, down from 0.8 percentage point for the first two rounds of easing.
Depleted as its arsenal may be, the Fed must stand ready to act again -- and to do even more if politicians fail to avert the fiscal disaster coming at the end of this year. The Fed might not be able to put millions of people back to work singlehandedly, but it can help protect what little we have gained.
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