Slack Attack

November 29th, 2012 at 6:15 am

At work on a bunch of indicators associated with the relationships between inequality, growth, income, poverty…stuff like that.  And, as usual, I’m struck by how much slack there’s been in the economy over the period when inequality has really taken off.

The much-cited Piketty and Saez data show inequality relatively flat from the late 1940s through to the late 1970s, then rising steeply after that (see figure 1A here).  In fact, they point out that since inequality began rising, we’ve transferred 15% of national income from the bottom 90% of households to the top 10%, a massive redistribution (their income data are pretax, pre-transfer, i.e., market incomes).

It is not a coincidence that the economy ran much hotter in the earlier, less unequal period relative to the latter.  The two figures compare CBO data on potential GDP and the full-employment unemployment rate with the actual values of GDP and unemployment in those years.  The top figure plots the ratio of actual GDP to potential, so values greater than one imply a negative output gap.

The bottom graph shows the unemployment rate and CBOs estimate of the unemployment rate consistent with full-employment, or the NAIRU.*

I drew in a vertical line at 1979 to separate out the two inequality regimes.  As you can see, most of the time, 1949-79, the unemployment rate was lower than the NAIRU and actual GDP was above potential.  In the top figure, the line is above one most of the time in the earlier period and mostly below one in the latter.  And of course, the output and unemployment rate gaps at the end of the figures—for the current economy—look like the biggest in the whole series.

In the underlying paper I’m writing on these observations, I argue that rising inequality is endogenous to (a function of) all this slack—it’s not hard to show that tighter job markets improve the bargaining power of less advantaged workers, and thus give them a better chance of claiming more of the growth they’re helping to generate.  But I can also think of ways in which inequality itself engenders slower growth over the longer term—I’ll get into that later.

For now, I just think the pictures are striking.  If you believe that in an economy like ours with low unionization rates and weak safety nets relative to other advanced economies, such slack explains a lot of what’s gone wrong over the past 30-plus years in terms of inequality, poverty, wage and income stagnation, I think you’re right.


Sources: CBO, BLS, BEA

*The non-accelerating inflationary rate of unemployment.  Look it up if you want, but it’s thought to be the value of unemployment consistent with stable inflation.  If the jobless rate were higher, inflation would slow and visa versa.  Which reminds me, I’ve left inflation out of the arguments above, and some might argue that we’ve traded faster growth for more stable inflation.  But the story’s not that simple.  In the later 1990s, when unemployment was below the NAIRU and GDP above potential (as you can see in the figures), inflation was decelerating!

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