Unemployment: Structural or Cyclical

March 28, 2012

A big policy debate about the U.S. economy concerns its vulnerability to accelerating inflation.  This argument hinges critically over whether 8.3% unemployment reflects a structural deficiency of skill supplies versus skilled worker demand or insufficient overall demand.  Officials at the Federal Reserve lie on both sides of the fence.  Notably, Chairman Bernanke, who exerts the greatest institutional influence on policy decisions, is among those stressing the level of aggregate demand.

The argument is intense because there is some truth to both positions.  The trend-line of job growth is presently at 162.926 million non-farm workers.  Jobs grew by 20.0% from 90.669 million in December 1979 to 108.809 million in December 1989 and by another 20.0% to 130.532 million in December 1999.  If one extends that vector with a well-established slope of 1.84% per year out to the present, the trend figure in February 2012 is 162.926 million, 30.3 million greater than the actual level of employment.  Put differently, actual workers are only 81.4% as many as their level ought to be.  Over the latest 15 reported months, 2.85 million net jobs have been created, a pace of 1.55% per annum that is improving but still slightly less than the trend of the last two decades of the 20th century.

Other signs of deficient demand are particularly noticeable in housing.  Existing home sales of 4.59 million, new home sales of 315K, the reading of 28 in the National Home Builders index, the FHFA house price index that’s 19.2% lower than in April 2007, and housing starts of 698K are all well below their historical norms.  Construction spending slid 0.1% in January, and real personal spending has posted three months without growth in a row.  Last month’s manufacturing purchasing managers index printed at a mere 52.4.  Today’s durable goods orders release for February reversed just two-fifths of January’s 3.6% plunge. 

The United States economy compares favorably with Europe only because of better demographics (i.e. population growth) and a smaller dose of fiscal restraint, but the fiscal bull dozer is coming next year.  Then let’s see how the U.S. economy purrs.  The Fed has imposed extremely low interest rates at both the short and long end of the maturity spectrum, and central bank money is very elevated.  Without real demand, however, neither cost-push nor serious demand-pull inflation are likely to take hold, and in any case, that process happens much more slowly than generally realized.  After averaging 1.2% per annum in the first half of the 1960s, CPI inflation rose to 3.9% per year in the second half of the decade, 6.6% in the first half of the 1970s, and 8.1% per year from end-1974 to end-1979.  There was a lot of lead time then when the central bank kept a sub-zero real federal funds rate despite very robust real economic growth and unacceptably high inflation.

Currency Thoughts is a by-product of the structural dimension of U.S. under-employment.  Following 34 years of gainful employment as an international economist and currency analyst including the last 19 with Ried Thunberg, I learned from a single phone call that my position and the whole international service of the company had been eliminated.  There was no face-to-face discussion, no advance warning that my job was in jeopardy, and no exit interview from the firm.  The economy soon became engulfed in its worst recession since the 1930s.  All competitors were struggling to hold onto to their own workers.  I had very specialized skills and was at an age that does not lend itself to reinvention.  This could be the story of countless 60-somethings, the first wave of the baby boomer generation that after unsuccessful job search simply dropped out of the labor force. 

One implication is that the non-inflationary unemployment floor is higher than realized but by no means above 7%, let alone 8%.  Another is that millions of prematurely retired people are spending less than they would do otherwise.  Since that’s going to happen for the rest of their lives, the economy’s predisposition for higher core inflation also has been reduced.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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