Fed Data Cruncher Finding No New Normal Unemployment Nationwide
Mary Daly holds up two charts containing 33 bars that all point down. They show eight industries getting hit equally hard after the 18-month recession ended in June 2009, suggesting that much of the past two years’ high unemployment is broad-based and should dissipate as the economy improves.
Daly is among researchers throughout the Federal Reserve system -- from San Francisco to Philadelphia and the board in Washington -- who are scouring data, examining models and gleaning anecdotes to determine why the jobless rate has remained stuck around 9 percent or more since April 2009. Most are reaching the conclusion that any long-term, structural shifts in the labor market aren’t significant enough to keep the U.S. from returning to a pre-crisis unemployment level of 5 percent to 6 percent by about 2016.
“If we were mis-measuring the natural rate of unemployment, I would expect to see rapid wage growth in some sectors offset by wage declines in others,” said Daly, 48, who heads the Federal Reserve Bank of San Francisco’s applied microeconomic research department. “I don’t see that. I see pretty uniform patterns across all sectors.”
This means Chairman Ben S. Bernanke and his colleagues should be able to bring down unemployment by continuing to keep interest rates near zero, eventually stimulating demand and encouraging businesses to start hiring again, said Sung Won Sohn, former chief economist at Wells Fargo & Co. and now an economics professor at California State University-Channel Islands. The risk is they will leave record stimulus in place too long, sparking a rising price spiral.
‘Flood of Liquidity’
“The research going on in the Federal Reserve is very important and critical in charting the future course of monetary policy, given the historically high jobless rate,” Sohn said. If the cause is primarily structural, then the Fed “will have simply created more future inflation because of a flood of liquidity it has created.”
The U.S. has recovered only 1.8 million of the more than 8.7 million jobs lost since January 2008, according to Labor Department figures, as companies such as Campbell Soup Co. (CPB) and Lockheed Martin Corp. (LMT) still shed workers. A report Friday showed the unemployment rate rose to 9.2 percent in June, the highest this year, from 9.1 percent in May.
When asked during a June 22 press conference if there’s a “structural issue” with unemployment, Bernanke said Fed officials “expect to see healthier job-creation numbers” and “payroll numbers improving relatively soon.” The U.S. is “still some years away from full employment in the sense of 5.5 percent, say,” he added.
Fewer Workers Quitting
Daly’s charts show that the number of hires per vacancy across all eight industries -- trade, transportation and utilities; construction; manufacturing; government; leisure and hospitality; education and health services; professional and business services; and others -- is “well below” where it should be compared with the period from December 2000 through December 2007, when the last expansion ended. Meanwhile, wage growth is decelerating and fewer workers are quitting, she said.
Researchers Raven Molloy and Christopher Smith of the Fed board in Washington and economist Abigail Wozniak at the University of Notre Dame in Indiana found no evidence that homeowners in states with the biggest declines in housing values had a harder time relocating than renters. Their work indicates that the inability to move from properties with negative equity isn’t contributing to a rise in structural unemployment.
Jobless College Graduates
Another telling indicator is joblessness among recent college graduates between the ages of 20 and 24, according to Daniel Aaronson, director of microeconomic research for the Federal Reserve Bank of Chicago. The rate climbed to 14.5 percent in June from 8 percent four years ago, as the national rate rose to 9.2 percent from 4.6 percent. The similarity points to cyclical causes because young people should be more able to relocate or switch industries to find work, said Aaronson, 43.
Nobel laureates Edmund Phelps and A. Michael Spence, along with Wall Street economists Drew Matus and Troy Davig, disagree with the Fed researchers, saying they aren’t paying enough attention to changes in the labor force that monetary policy can’t fix. Matus, a senior U.S. economist at UBS Securities LLC in Stamford, Connecticut, noted that 44.4 percent of the people who were unemployed in June have been out of work for 27 weeks or more; in 2001, the share was as low as 10 percent.
“There’s some risk that they don’t get it right,” said Phelps, who helped pioneer the concept of a natural rate for unemployment in the 1960s. “But there’s some risk they don’t get it at all. For one thing, the Fed underestimates the strength of structural forces pulling the economy back to a new normal, so there is greater risk of building up too much liquidity and unleashing an accidental burst of inflation.”
Spurring Higher Prices
The further the Fed estimates unemployment can fall without spurring higher prices, the greater the risk policy makers will maintain record stimulus and spark 1970s-style price increases, said Davig, a senior economist at Barclays Capital in New York and former economist at the Federal Reserve Bank of Kansas City.
Rising inflation expectations, as measured by the five- year, five-year-forward break-even rate, would prompt some investors to sell long-term Treasuries, buy Treasury Inflation- Protected Securities and push the rate even higher, he said, adding that “it’s not in our forecast, but it’s something we see on the table.” Barclays, on average, has the largest market share of TIPS trading by volume.
Rising Treasury Yields
Yields on 10-year Treasuries, which are a benchmark for everything from home mortgages to corporate bonds, have climbed to 3.03 percent on July 8 from 2.86 percent on June 24. The Fed’s five-year forward break-even inflation rate has risen to 3.04 percent on July 6 from 2.77 percent on June 15.
The impact of structural changes on the natural rate of unemployment, or level needed to keep inflation from igniting, is key to determining how effective Fed policy can be. The higher the rate -- also known as the non-accelerating inflation rate of unemployment or NAIRU -- the less policy makers can do to stimulate the economy without stoking higher prices, and the more crucial it is for the U.S. to take other steps, such as retraining workers.
The lower the natural rate, the stronger the argument that the central bank still has room to encourage growth and boost job creation. Fed officials put the natural rate at 5 percent to 6 percent, which they expect to see in the next five or six years, based on forecasts released June 22.
Phelps, 77, who teaches at Columbia University in New York and won the Nobel Prize for economics in 2006, estimates the natural rate has climbed to about 7 percent from 5.5 percent since the mid-1990s. He says the labor force will shrink with the exodus of retiring baby boomers and innovation is declining, lowering productivity growth.
Shigeru Fujita, a senior economist at the Federal Reserve Bank of Philadelphia, also sees significant structural forces at work, pointing to labor’s declining share of the economy since the early 1980s, measured by workers’ compensation as a percentage of gross domestic product.
The economy now is following a path similar to the jobless recoveries after economic slumps ended in 1991 and 2001, “even though the Great Recession was very different,” said Fujita, 40, who joined the bank in 2004. “There are many things that traditional economic models can’t explain, one of which is jobless recoveries.”
Other economists say high unemployment is largely the result of inadequate demand in the economy, including Princeton University professor Paul Krugman, another Nobel laureate, and Robert E. Hall, head of the National Bureau of Economic Research committee that dates the start and end of recessions.
“The Fed is highly adaptive: It pays close attention to actual and forecasted inflation,” said Hall, who teaches at Stanford University in California. Actual inflation is likely to remain stable “even if the economy heats up again.”
The availability of extended unemployment benefits may have increased joblessness by as much as 0.8 percentage point and should have only a transitory effect as they expire and economic conditions improve, according to a January paper by Daly and San Francisco Fed researchers Bart Hobijn and Robert Valletta. Daly puts the natural rate at 6.25 percent and predicts it will fall to as low as 5.5 percent in five or more years.
“We concluded in January that the severity of the recession did increase the natural rate of unemployment,” she said in an interview from her office at the bank. “But part of that increase is temporary and will go away as the economy recovers. Nothing in the data that has come out since then suggests our views should change.”
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