No question, the unemployment rate paints an incomplete picture…and yet…

July 15th, 2019 at 9:34 am

It’s long been understood by anyone trying to assess the labor market that the unemployment rate is, by itself, not up to the task. Most importantly, it leaves out those not looking for work, but it’s also not adjusted for demographic change, nor does it factor in those who are working fewer hours than they’d like. It combines racial groups with persistently different levels of unemployment. At times like now, these shortcomings can lead this premiere indicator to underestimate the extent of slack in the job market.

This WSJ article from yesterday–“For decoding labor market, unemployment rate may not do the job”–is but the latest salvo in this healthy discussion about the need for a dashboard, not a single dial.

And yet, most of us, when trying to provide a quick overview of economic conditions, still cite the top-line rate, a practice I’d like to defend here, with at least moderate conviction, based on the correlation matrix below. The  data run from 1994 through now, and the variables are the u-6 underemployment rate, the prime-age employment rate, the Richmond Fed’s non-employment index, both with and w/out those involuntary part-timers, and the black unemployment rate.

Sources: BLS, Richmond Fed

As you see, if we’re comparing levels, the unemployment rate correlates highly–close to unity in most cases–with the other variables in the table. Even the non-employment index, “an alternative to the standard unemployment rate that includes all non-employed individuals and accounts for persistent differences in their labor market attachment,” correlates with unemployment at 0.99.

Of course, we don’t just look at levels. We also pay a lot of attention to changes in these variables, and, as is always the case, change correlations are a lot lower than level correlations. We also see some interesting variation. When it comes to both prime-age epops and the black unemployment rate, changes carry different information relative to the topline jobless rate than do the levels. For African-Americans, this is due to their “high-Beta” relationship with the overall rate: a one-point change in unemployment correlates with a 1.5 change in the black rate. That’s a great elasticity to tap in high-pressure labor markets, and a hugely negative one in recessions.

Feel free to add other variables to the comparison, of course, as this is surely an incomplete list. And let me be unequivocal about the need for a dashboard of indicators, including very importantly, “price” variables like wage and price growth (see the subhead of the WSJ piece: “wage growth has been muted and inflation weak, leading economists to come up with new measures of joblessness”). The fact of moderate-at-best wage growth in recent months is one of the main reasons I suspect there’s still some slack in the U.S. job market, even at 3.7 percent unemployment.

But we shouldn’t be ashamed to cite the unemployment rate as a key indicator of labor market health. There’s no single, perfectly informative measure, but the good news is that all the imperfect ones are pretty highly correlated.

Judy Shelton and her sponsor—President Trump—want to tie the hands of the Fed

July 10th, 2019 at 7:31 am

When someone seeking confirmation to high office has a paper trail fraught with positions antithetical to their confirmation, their theme song quickly becomes Shaggy’s It Wasn’t Me, as they flip and flop to disavow their earlier convictions.

The most recent purveyor of this strategy is Judy Shelton, one of President Trump’s most recent likely nominees for the Federal Reserve. Ms. Shelton, who worked on Trump’s campaign and transition team, currently holds a Senate-confirmed position as the U.S. representative to the European Bank for Reconstruction and Development.

After reviewing her writings and comparing them with what she’s saying in her current campaign to get the Fed job, I’m convinced that her appointment would be extremely problematic for at least two reasons. One, she would try to undermine the flexibility that’s so important to today’s monetary policy, and two, she’d give the president a voice inside of the Fed, compromising the essential independence of the central bank.

This judgement stems in part from the extent to which Ms. Shelton is trying to remake herself into an easy-money dove in the president’s image, or at least his image since he’s taken office. Before that, both Trump and Shelton lambasted the Fed for helping Obama by holding interest rates down (in fact, the Fed was fighting the recession and initially weak recovery). Now, of course, he wants them to cut rates to help him.

And contrary to everything she’s stood for in the past, Ms. Shelton agrees with him.

To understand the real Ms. Shelton, as opposed to her current incarnation, you need to understand why Larry Kudlow, one of Trump’s top economic advisors, called her “a leading hard money conservative.” “Hard money,” in this context, refers to wresting control of economic policy away from institutions like the Fed and linking the value of money to a fixed base, most typically gold. And, in fact, Ms. Shelton has not only called for the U.S. to go back on the gold standard, but for the world to do so.

What’s wrong with that? Gold bugs like Ms. Shelton maintain a religious—as opposed to an empirical—belief that linking currency to gold will lead to less inflation and more stable economic outcomes. But history teaches the opposite, which is really common sense. When currencies were tied to gold, the supply of the benchmark metal was neither stable, predictable, nor able to grow with populations and demands for greater economic activity.

That didn’t suppress inflation, it just made it more volatile. Same with growth and financial stability, both of which were much rockier when the gold standard ruled.

A key reason for that record is that being locked to the gold standard (or any such fixed regime) results in an inability of policy makers to respond to shocks. For economies across the globe, this has long been understood to be a bug and a major rationale for standing up an independent central bank. But for Ms. Shelton, such inflexibility is a feature.

Or, at least, it was. Now she’s mimicking Trump and is impersonating a monetary dove, calling for the Fed to aggressively cut interest rates (and doing so from the lobby of the Trump Hotel). Still, if you look carefully, you can see a hawk in dove’s feathers.

This gets a little technical, but it’s worth unpacking. In her newfound drive for easy money (low interest rates), Ms. Shelton has called for the Fed to stop paying interest on “excess reserves” held by its member banks. To stimulate lending during the Great Recession, the Fed loaned banks a lot more money than in the past (this is often described as the Fed “expanding their balance sheet”). Now, as the Fed slowly unwinds all this borrowing, it either pays interest on these reserves or it loses control of its benchmark interest rate. Were the central bank not to pay interest on these reserves, member banks would compete with each other to lend them out at ever lower rates until the target rate hit zero.

This decline in lending rates would please Ms. Shelton’s sponsor (Trump) to no end. But the next thing that would happen is that to regain control of their funds rate, the Fed would have to quickly get those excess reserves off their books. That means taking a lot money out of the banking system, and quickly. Such tightening would push the other way from Ms. Shelton’s scheme, raising rates.

In other words, in making a play for low rates, Ms. Shelton’s plan would deliver higher rates. At this point, I have no idea what she really wants. All I know is that she’s incoherent.

That said, there’s a theme to this plan that’s consistent with her previously held views, and it’s a way in which both Ms. Shelton and Trump want the same thing: to tie the hands of the Fed. Whether it’s her old gold standard or her new opposition to the way the Fed controls its funds rate, my foremost concern about her nomination is that Ms. Shelton will be Trump’s agent inside the bank and will do his bidding regardless of what the real economy needs.

And of this you can be sure: history is littered with economies that were brought to their knees because the central bank came under the thumb of a politician.

To be clear, Ms. Shelton is an accomplished economist and a provocative writer. But she also an actor, a political actor trying to get a part, one for which she’s uniquely unqualified.

Why a Fed rate cut makes sense

July 9th, 2019 at 2:33 pm

[written with Mark Zandi, chief economist of Moody’s Analytics]

This is a post about one-quarter of one percent.

That’s the amount by which the Federal Reserve is expected to reduce the federal funds rate, the key interest rate they control, when they meet at the end of this month. If that sounds like too small a change to get worked up about, we assure you, Fed rate changes can be a big deal, especially when they change direction. The central bank had been steadily raising rates over the past several years, and only just a few months ago was predicting further rate increases this year and next.

The decision to cut rates has become a bit more complicated, as last week’s solid jobs report weakened the case for the cut. Why add interest-rate stimulus to an economy that’s already going strong?

Moreover, this month, the current economic expansion—meaning the time between the end of the last recession and the start of the next one—became the longest on record. Based on growth rates compared to past downturns, it has been more long than strong, but the unemployment rate has been hovering near 50-year lows, and the combination of abundant job creation, low inflation, and better wages have powered that ever-acquisitive creature, the American consumer. Given that our GDP is 70 percent consumer spending—in Europe, it’s 55 percent; in China, it’s 40 percent—the strong labor market can go a long way toward sustaining the expansion.

So, again, why cut rates?

First, for all the July fireworks around last week’s strong job gains (224,000 jobs created, compared to 72,000 the month before), the job market is slowing. The monthly data are noisy, so to get at the underlying trend, you’ve got to average out the noise. Over the first half of this year, employers have added about 170,000 jobs per month. That’s a healthy clip, no doubt, but last year the monthly gain was 235,000.

This slowdown could intensify, courtesy of President Trump’s trade war. While the President has ostensibly agreed to a truce in the war with China – freezing the current tariffs and relaxing restrictions on the Chinese tech-company Huawei – this will do little to reduce the uncertainty and resulting angst of American companies doing business with the rest of the world. In fact, the usual pattern has been periods of truce followed by more chaos, demands, threats, and, in some cases, actions in the form of more or higher tariffs.

This pattern has left businesses demonstrably nervous. Moody’s Analytics measure of global business confidence is as weak as it has been since the economy began to recover from the financial crisis a decade ago. Similarly, businesses’ expectations as to how well they think they’ll be doing later this year have slid to where they were just prior to the financial crisis. Two-thirds of respondents to Duke University’s quarterly survey of company CFOs say a recession is likely by the end of 2020; Morgan Stanley’s business conditions index, designed to capture turning points in the economy, suffered its largest one-month decline on record in May.

As you might expect, such sentiments tend to correspond to weak investment plans. Despite the tax cuts corporations got beginning last year, and contrary to the predictions of advocates for those cuts, investment has flat lined over the past year.

If these sentiments and weak investment behavior persist, eventually businesses will cut back on their hiring. If so, and unemployment rises, even a little bit, and even from very low levels, recession becomes a real possibility. That’s because those consumers powering the economy will quickly sense the weakening job market and turn more cautious in their spending. Businesses will see this and pull-back further on jobs. The virtuous economic cycle that characterizes the economy today, will turn into a vicious one.

A one-quarter percent Fed rate cut at their late July meeting can help forestall this possibility. A small cut is a way by which monetary policy takes out an insurance policy against the impact of the trade war, or any of a litany of other threats from Brexit to another government shutdown.

What’s the argument against a rate cut? It’s that the labor market is already at or near full employment and any extra stimulus might push unemployment down even further, risking overheating and higher inflation.

But even if the aforementioned pressures fade and the expansion continues apace, the Fed has plenty of time and firepower to respond to price pressures. Inflation is low, arguably too low. The Fed wants inflation to hover around 2 percent per year. It’s fine for price growth to be a bit below this target some of the time, but only if it is also above the target other times, so that it averages out to be 2 percent over time. But since the last recession, inflation has never sustainably reached the target, and this undershoot is starting to show up in people’s expectations about the future course of price growth. If these diminished expectations get cemented, it could take a long time to get inflation back on track. Just ask the Japanese, as they’ve been trying for several decades.

No one know when the next recession will occur. But we are confident that growth is slowing, and there are serious threats, mostly of our own making, to the expansion. This warrants a rate cut when the Fed meets in a few weeks.

More evidence–this time from CBO–that higher (even much higher) minimum wages largely do what they’re supposed to do.

July 8th, 2019 at 2:39 pm

Raising the federal minimum wage to $15 per hour by 2025 would lift the pay of 27.3 million workers—17 percent of the workforce—according to a new report from the Congressional Budget Office. It would raise the incomes of poor families by 5 percent and thus reduce the number of people in poverty by 1.3 million. Since these low-end gains would be partially financed out of profits, the increase in the wage floor would reduce inequality.

CBO also estimates that “1.3 million workers who would otherwise be employed would be jobless in an average week in 2025.” Because economists’ estimates of the job-loss effects from minimum wage increase are so wide-ranging—some studies find little-to-no job loss impacts; other find more—CBO estimates that there’s a two-thirds chance that the actual change in employment is between 0 and -3.7 million. Interestingly, -1.3 million is not the midpoint between 0 and -3.7, suggesting the budget office gave a bit more weight to studies finding less evidence of job-loss effects.

Thus spoke Zarathustra the CBO. Should this lead objective policy makers to embrace or eschew the policy to increase the federal minimum wage to $15 in 2025 (assume for this exercise that “objective policy makers” exist)?

I’d give a solid push towards embrace. It’s a progressive policy that’s long been shown to largely hit its goals of boosting the earnings of low-wage workers whose families seriously need the income. Yes, the report warns that some will be hurt by the increase, but the best research suggests their job-loss estimate may be too high. Moreover, even if they’re right, the ratio of helped-to-hurt is 21 (27.3m/1.3m). And given the extent of turnover in the low-wage labor market, many of those 1.3 million workers will eventually find new jobs, jobs which pay a lot better than their old ones.

Full disclosure: I’ve long advocated for minimum wage increases, so my “embrace” won’t surprise those who’ve followed that work. But the reason why I—and, more importantly, progressive institutions like the Economic Policy Institute, CBPP, CAP, and many others—have long advocated for minimum wage increases is that a deep body of uniquely high-quality research finds that prior increases have had their intended effects of raising low-wage workers’ incomes without leading to significant job loss.

But isn’t the $15 minimum wage a lot more ambitious than prior increases (the CBO report also simulates $10 and $12 increases)? It is, and as such, it will have a much larger “bite” than prior increases, meaning it will apply to a larger share of low-wage workers than past increases. Figure 4 in the report shows that the 1991 increase directly affected about 6 percent of workers; this one could affect almost 14 percent.

To evaluate this concern, go back to my comment about “uniquely high-quality research.” By that I mean that because so many states and cities have implemented higher wage floors on their own—there are over 130 such cases over the last few decades—researchers have been able to conduct many more experimental-type studies than in virtually any other area of economics, comparing outcomes in places that raised their wage floor to outcomes in places that did not. Moreover, some of these increases have had comparable bites to the $15 wage simulated by CBO, as shown by this new paper by Godoey and Reich.

The importance of this new report relative to today’s CBO release is that G&R focus especially on high-impact (large bite) increases. They find “positive wage effects but do not detect adverse effects on employment, weekly hours or annual weeks worked. We do not find negative employment effects among women, blacks and/or Hispanics. We do find substantial declines in household and child poverty.”

No single study will end this debate, but as someone who’s been in this debate for about 30 years, believe me: especially since the path-breaking work of the late (man, that’s still painful to write) Alan Krueger and David Card, the evidence from this sort of controlled study has changed many economists’ and policy makers’ views on minimum wages.

The simple, classical model—raise pay by mandate and everyone affected gets hurt—is clearly wrong, as the CBO report shows. Just how wrong is it is something we’ll continue to argue about. But in the meantime, policy makers who want to improve the living standards of low-wage workers, reduce poverty, and push back on inequality can rest assured that, as the budget office’s new report shows, the evidence is on their side. The benefits of the increase—even a significant increase like this one—far outweigh the costs.

July jobs: nice pop on payrolls but flat wage growth

July 5th, 2019 at 9:18 am

[This jobs report is an important one in terms of assessing the impact of headwinds on the job market, but because it’s sort of a holiday, I’ll just offer up a truncated, bullet-point report. As always, thanks to Kathleen Bryant, who got up early on vacation to help me out!]

Toplines:

–Payrolls rose 224,000 last month, well above expectations for ~165K. Though we never want to over-weight one month of noisy data, that’s an important number, suggesting that building economic headwinds haven’t dented job creation much yet at all.

–Our monthly smoother shows average monthly job gains over 3, 6, and 12-month windows. Even including May’s weak 72K (revised) gain, the average over both the past 3 and 6 months has been around 170K jobs/month. That’s a slight downshift from the 12-month average but still a very solid number, one that should handily support the ongoing expansion.

–The unemployment rate ticked up to 3.7% (a statistically insignificant change, btw), but that was mostly due to more people coming into the labor force–the participation rate nudged up 0.1 ppts to 62.9%.

–That’s all good news, but the evolving wage story is less so. As the figures below reveal, our 6-mos rolling average of yr/yr nominal wage growth shows the trend (versus the noisier monthly values) is stalled or even trailing off a bit. This too, is an important finding, suggesting that a) there’s still “room-to-run” in this expansion as labor supply doesn’t appear to be tapped out, b) even with unemployment near 50-yer lows, too many workers still lack the bargaining clout they need.

–That said, nominal wage gains are beating consumer inflation, which is running a bit below 2%, so the buying power of paychecks is rising. Again, this combination of solid job gains, low inflation, and nominal wage growth around 3% should handily support the expansion in at least the near term.

Other observations:

–Gov’t added 33K jobs, and some are saying that’s related to hiring for the decennial Census. Such hiring does and will cause a temporary spike in payrolls, but federal gov’t employment was up only 2K last month. Local gov’t added 29K jobs, so this doesn’t look like a Census issue.

–Manufacturing had a better month in June, adding 17K jobs after being flat for most of the year. One month doesn’t change the recent trend, and the factory sector remains high on the watch list, as the trade war, stronger dollar, and our expanding trade deficit may put downward pressure on the sector in coming months.

–This is a tricky jobs report the Federal Reserve, which is meeting later this month and is expected to cut its benchmark interest rate. But with unemployment below their estimate of the “natural rate” (the lowest jobless rate believed to be consistent with stable prices) and average payrolls gains well north of the “equilibrium” level (the level required to keep unemployment from rising), they will not see a rate cut as an obvious necessity.

–Pushing the other direction–toward a rate cut–are below-target inflation and the absence of wage acceleration.

–So, it’s quantities versus prices! May the best variable win. While I carry a fairly hefty rate-cut bias, I’m not sure what I’d vote for were I at the FOMC table. Given the need for sustained real wage growth for the majority of workers left behind during decades of rising inequality, I’m leaning toward “prices,” as in cut rates in the hopes of even lower unemployment and the possibility of bending the wage-growth curve back up. But I’ll think on it and get back to you later with a definitive call!