As central bankers gather for their annual conference in Jackson Hole, Wyoming, a top agenda item is evaluating the current and future amount of slack in the US economy. In this regard, they’d be well advised to check out this new study from the two economists at the Economic Policy Institute which provides an exhaustive examination of the issue.
If EPI’s Josh Bivens and Heidi Shierholz left out any revealing indicators in their comprehensive diagnosis, I can’t say what they are. I’ll summarize in a moment, but the punchline is that under pretty much every rock—and they left no stone unturned—they find evidence of under-utilization and cyclical as opposed to structural weakness in demand.
That may sound both obvious and depressing, but I’d argue it’s neither. First, every day I’m hearing influential voices arguing we’re closing in on full employment such that the Federal Reserve should move their foot from the monetary accelerator to the brake. Just this morning, Esther George, president of the Kansas City Fed, said, “When you see the economy getting as close as we are to full employment, to stable inflation, it would suggest to me that the time has come to [raise rates].”
So, while Bivens and Shierholz’s (let’s call them J&H, for Josh and Heidi, so as to avoid the unfortunate and inaccurate acronym “B&S”) findings will be unsurprising to many, don’t kid yourself: their results are not as widely accepted as they should be.
Why isn’t this depressing? Because structural problems are much harder to repair than cyclical ones. If J&H are correct, and I think they are, as the recovery continues to build, serious problems like productivity-dampening under-investment in capital goods, depressed labor force participation, and reduced estimates of potential growth can be reversed.
True, the Congress won’t help with the cyclical problem, but a) that’s old news, and b) as I’ve shown in various places, their impact on growth has actually moved from fiscal drag to fiscal neutrality, and “do-no-harm” is the best you can hope for from this lot.
Read the paper yourself, or at least just look at the figures and tables, but here are some highlights:
–actual GDP still remains well below potential GDP, even as the deep recession and weak recovery has reduced the latter;
–inflation and the growth of unit labor costs (real compensation growth adjusted for productivity) remain historically low even in the face of sharp increases in the money supply;
–interest rates remain very low even in the face (at least a few years ago) of large budget deficits, though of course the Fed itself is a key determinant of this outcome;
–corporate profits remain high and the labor share of national income remains low, suggesting labor market slack, lack of wage pressures, and room for non-inflationary growth “paid for” through a rebalancing of these “factor shares.”
–neither measures of quantity (unemployment) or price (wages) reveal evidence of a skills mismatch—a structural problem—in the job market;
–as a number of papers have shown in recent weeks, long-term unemployment is a factor depressing wage growth, meaning that these job seekers represent cyclical, not structural, labor market slack; in J&E’s language: “the [long-term] unemployed have largely not hardened into structural unemployment in the wake of the Great Recession and slow recovery, which means that we can lower the long-term unemployment rate by boosting aggregate demand.”
–in fact, long-term unemployment rate, which has in fact responded in a cyclical manner in recent months (i.e., it’s fallen fairly sharply as the job market has improved) is about where you’d expect it to be given the cyclical slack documented throughout the piece.
All of this leaves us with two related problems. One, it is essential for the recovery to persist and accelerate to squeeze out the cyclical weakness documented by J&H. Two, if that does not occur, there is the very real potential for cyclical to morph into structural. That’s why the stakes for supportive monetary policy remain so high. Get this wrong by listening too closely to the voices cited above, and the damage will not be fleeting. It will be lasting.