Fed Studies Show Damage to Labor Market Is Reversible
Most of the damage inflicted on the U.S. labor market by the recession is reversible, according to Federal Reserve research, leaving open the possibility that additional stimulus will be effective in reducing joblessness.
About one-third, or 1.5 percentage points, of the jump in unemployment from 5 percent as the economic slump began to its 10 percent peak in October 2009 can be traced to a mismatch between the supply of labor and job openings, according to a study released this month by the Federal Reserve Bank of New York. That leaves the remainder due mainly to a lack of demand.
“There is still considerable weakness in the labor market,” Aysegul Sahin, one of the authors and a New York Fed economist, said in an interview. “We see that the weakness in the labor market is not specific to certain groups, such as certain occupations or certain locations. This points to a case where labor market weakness can be attributable to the overall weakness in the economy.”
That conclusion goes to the heart of a debate pitting economists at banks like UBS Securities LLC and Barclays Plc who say the economy has fundamentally changed against central bankers, including Chairman Ben S. Bernanke, who say the distortions are transitory. A permanent shift would mean policy makers applying additional stimulus risk spurring inflation by driving unemployment down too far too quickly, while a temporary dislocation would indicate more can be done.
“There is a structural unemployment problem in the U.S.,” said UBS economist Drew Matus. “The best the economy can do, even if it is performing well, is an unemployment rate that is probably significantly higher than it was pre-crisis.”
UBS’s Matus puts the new equilibrium level of U.S. joblessness in the range of 7 percent to 8 percent.
Fed research, on the other hand, suggests this so-called natural rate of unemployment may be as low as 6 percent. Even that level could come down more as the economy heals, work by Sahin and colleagues at the San Francisco Fed shows.
In today’s developments, most stocks fell, after the Standard & Poor’s 500 Index rose to its highest level since April, as investors were concerned European leaders will fail to quell the region’s debt crisis. The 500 Index dropped less than 0.1 percent to 1,418.13 at the 4 p.m. close in New York.
In Europe, data showed U.K. home sellers cut asking prices by a record for the month of August after the London Olympic Games and an uncertain economic outlook distracted potential buyers. Elsewhere, Thailand signaled growth in the second half of this year may be weaker than previously forecast as the global slowdown hurts exports from Southeast Asia’s second-biggest economy.
The gap between the current jobless rate of 8.3 percent and what Matus and the Fed have estimated as the natural rate is central to gauging the amount of labor-market slack. There is always some joblessness -- the natural rate of unemployment -- because geography and a lack of skills can limit the ability of those out of work to fill new openings instantly.
Matus and economists at Barclays have focused on a shift in the Beveridge Curve, which measures the relationship between job openings and unemployment, for evidence the natural rate has moved higher.
Named after British economist William Beveridge, the curve indicates there are more jobs available today than there were before the recession given the current level of unemployment.
Fed researchers counter that analysis of that relationship in isolation is “problematic” because it does not consider firms’ incentives to create new positions, which also alter labor-market dynamics. Their estimate of a lower rate is based on pairing the Beveridge curve with what they call the job-creation curve, a measure of employers’ willingness to offer new positions at any given level of unemployment.
Neglecting this second relationship would be tantamount to trying to determine the price of a good without taking into account both demand and supply, said Zach Pandl, a senior interest-rate strategist at Columbia Management, whose analysis also puts equilibrium unemployment around 6 percent.
Bernanke is among those at the central bank who are looking beyond the shift in the curve because they believe the jump in unemployment is temporary.
“A more in-depth analysis of the evidence suggests that the apparent shift in the relationship between vacancies and unemployment is neither unusual for a recession nor likely to be persistent,” the chairman said a March 26 speech to the National Association for Business Economics.
Similar shifts have occurred following past recessions only to have the prior relationship reassert itself as the recoveries progressed, according to central bank research. Spikes in firings, the availability of extended jobless benefits and a growing pool of applicants from which to choose during economic slumps may induce the temporary shifts, Bernanke said.
San Francisco Fed President John Williams echoed that point in May, saying he expects his current estimate for the natural rate of 6 percent to 6.5 percent to fall to 5.5 percent.
Economists at Barclays are more skeptical.
“Our view is that something more like the ‘70s plays out,” when the relationship took about a decade to reassert itself, said Peter Newland, a New York-based economist at Barclays. He estimated the natural rate is near 7 percent and said emerging signs of mismatch at manufacturers may keep unemployment elevated.
The skeptics point to the rate of inflation as additional evidence that things have changed because price pressures usually increase as unemployment falls near its natural level.
The consumer price index, excluding food and fuel costs, rose 2.1 percent in the 12-months ended in July, according to figures from the Labor Department. Central bank policy makers aim for 2 percent inflation as part of their dual mandate of stable prices and maximum employment.
“This elementary fact that the inflation rate is more or less back in the neighborhood of 2 percent takes the wind out of the argument put forward by some that our problem is deficient demand,” Edmund Phelps, who won the Nobel Prize for economics in 2006, said in an interview.
The natural rate of unemployment is around 7 percent, a level to which joblessness could fall over time were businesses to create new jobs through innovation, said Phelps, the director of the Center on Capitalism and Society and a professor at Columbia University in New York.
“The only policy question is really whether we want monetary policy to push the gas pedal to the floorboard in order to accelerate that recovery as much as possible and never mind the increase in inflation that might be a side-effect,” he said.
With 12.8 million Americans unemployed and the share of the working-age population with a job hovering near the lowest level in three decades, the ability to quickly stimulate hiring is a key to reviving the recovery.
Even if inflation weren’t a concern, the Fed’s definition of what constitutes a temporary shift in labor-market dynamics may prove disheartening, said UBS’s Matus.
“For all we know, a temporary move could be three to five years, and for market participants and the average American, that might as well be permanent,” Matus said.
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