Wednesday, July 28, 2010

Is It Structural or Cyclical Unemployment?

The Economist magazine is asking whether there has been an increase in America's structural unemployment. If the answer is yes then macroeconomic policy may be limited in how much it can do to lower unemployment. Thus, even if the Fed further stabilized aggregate demand the benefits for the unemployed and  the broader economy may be muted.  My own view has been that both structural and cyclical unemployment have been important in this economic cycle. On one hand, the the rapid productivity gains in 2009 (they are down in 2010) point to increased structural unemployment, a point recently made by David Altig. On the other hand, there is evidence consistent with a slowdown in aggregate demand which points to increased cyclical unemployment.

So how important are these two forms of unemployment?  Justin Weidner and John C. Williams of the San Francisco Fed have a note that helps answer this question.  In the note the authors look at the various measures of the output gap and via Okun's Law, the implied natural rate of unemployment.  Now the natural rate of unemployment is the sum of frictional unemployment and structural unemployment.  Frictional unemployment, which is a function of search costs, most likely hasn't changed that much.  Thus, any change in the natural rate of unemployment is probably coming from changes in structural unemployment.  Below are unemployment tables constructed from the different measures of the output gap discussed in this note.  The first table shows the implied natural rate of unemployment and the second one shows the implied cyclical rate of unemployment (i.e. actual unemployment rate minus the natural rate of unemployment).  Click on the figure to enlarge it:



What this table indicates is that since 2008:Q4 cyclical unemployment has been hovering around 3.0% while the natural rate has been growing steadily and now is around 6.8%. This data, if correct, suggests that folks like me who call on the Fed to do more in terms of stabilizing aggregate demand should realize the limits of macroeconomic policy.  Still, providing a stable monetary and aggregate demand enironment in which the structural adjustments can take place should not be overlooked.

11 comments:

  1. The extent of structural vs. cyclical unemployment is academic. So far a policy goes, the prescription is the same: boost aggregate demand and do not frustrate labour reallocation.

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  2. An Okun's law argument is only as good as the estimate of the slope - which is probably subject to wild inaccuracies. Especially given the numbers in the table, with real unemployment (U6) around 16%.

    But the structural vs cyclical argument is a bit fatuous, isn't it? The focus should be on solutions now, before the structural employment becomes intractable.

    Sumner's NGDP growth solution is an unrealistic policy idea recycled from Bob Dole's presidential campaign. Krugman pointed out 14 years ago that the correct target for policy is the inflation rate.

    http://pages.stern.nyu.edu/~nroubini/NYT/krugeconairu.htm

    But who reads Krugman anymore?

    JzB

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  3. In addition to uncertainty about the size of the Okun's law coefficient (as noted by Jazzbumpa), there is a problem with nonlinear relationships that are assumed to be linear and dynamic relationships that are treated as static.

    For example, the relationship between job vacancies and output is both dynamic and nonlinear. The relationship cannot be linear, because the number of job vacancies cannot go below zero, and it cannot be static, because job vacancies take time to fill. During the early part of a recovery from a very deep recession, a linear, static analysis of job vacancies will underestimate the size of output gap (and therefore overestimate the amount of structural unemployment). First of all, the non-linearity is such that, the deeper a recession gets, the less marginal decline in job vacancies is associated with a marginal increase in the output gap. (That should be clear if you do a thought experiment where the number of job vacancies goes to zero.) Thus, the actual output gap, after a deep recession, will be larger (more negative) than a linear analysis of job vacancies would lead one to believe. Second, since job vacancies take time to fill, the number of job vacancies will rise during the early part of a recovery, but the actual output gap won't be reduced until those vacancies are filled. Thus during the early part of the recovery, in a static analysis, it will appear that the output gap has fallen when in fact it hasn't yet fallen. This will also result in an overestimate of the amount of structural unemployment.

    I suspect that similar problems exist for some of the other estimates they use. For example, the Laubach-Williams method (I'm just guessing) may assume a linear relationship between inflation and the output gap. Many (most?) economists believe that the stickiness of wages is asymmetric, implying that, when inflation rate is already close to zero, marginal widening of the output gap has less influence on the inflation rate than when the inflation rate is higher. Moreover, there is evidence to suggest, even apart fom the prior level of the inflation rate, that the short-run Phillips curve is convex (in unemployment). Thus a linear method will tend to underestimate the severity of the output gap (and thus overestimate the amount of structural unemployment) when the output gap is large and negative and when the inflation rate is low.

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  4. Jazzbumpa,

    Sumner published a paper in 1989 on targeting nominal income. Still, I was hoping to discover that Bob Dole's presidential campaign had picked up on the idea for his campaign in 1996. We academic economists are always happy with some politician takes our notions seriously.

    But I couldn't find anything. The paper you cite was about a proposal to have the Fed focus solely on price level stability and not worry about real output or employment. Krugman argued that a the Fed should aim at keeping inflation at 3% rather than zero.

    What does that have to do with targeting nominal GDP?

    While a proper target for nominal GDP can be consistent with a zero trend inflation rate, it can also be consistent other trends--including 2 or 3 percent. What is important about it, however, is that market forces determine both real output and the price level/inflation rate--in an environment, of course, of NGDP being expected to remain on target.

    Sumner mostly emphasized the need to keep nominal GDP growing 5%, which is consistent with a 2% trend inflation rate. Admittedly, I prefer a 3% target growth path for money expenditures, which should result stable prices on average.

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  5. The structural unemployment that is developing is not just about a "skill mismatch." It is ultimately going to be about a total lack of demand for skills (and workers). It is something unprecidented and it is caused by advancing technology. And ,no, it is NOT the same thing that has been going on for decades. Technology is moving faster and faster. In the next couple of decades will will see a staggering level of progress.

    For an excellent overview of this problem, check out this book (available as a free PDF): The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future. (http://www.thelightsinthetunnel.com).

    If there were a textbook on this issue of technological unemployment and where it will lead, this book is it. I wish every economist would take a break from data analysis and READ THIS BOOK.

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  6. Mr. Anonymous,

    I am interested in technological change. However, I am curious, what is the path of real wages, real interest rates, and the real prices of natural resources described by this book? Does the book really say that there will be no use for human labor? Exactly who will real wages move towards zero over time?

    Perhaps there is serious economic analysis, but I have my doubts.

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  7. David,

    Service sector job losses (as of Aug, '09) made up 50% of the total in this recession. In the two previous recessions, the number was closer to 18%. This poses a number of questions:

    What is the nature of a service sector output gap? The concept itself seems rooted in the behavior of industrial capacity. This made sense when job losses were concentrated in manufacturing.

    Also, service sector jobs presumably have less sticky wages. Why, then, does the adjustment in wages (as indicated by the record % of unemployed over 26wks) much slower in this recession? One would think that the long-term service sector unemployed would be much quicker to offer their services for less money. Why haven't we experienced more wage deflation?

    I also wonder whether regressions on previous recessions can tell us much about the current one given how different it is behaving.

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  8. I suppose unemployment is cyclical if the worker knows that there will be a job to go back to when business picks up. Much of today's unemployment is structural because a good service sector job represents an investment on the part of both the employer and the employee. The recession is the result of a decade of massive mis-directed investment in the US economy. Many of the jobs that are lost represent investments that are effectively written off. To get these people back to work, potential employers have to decide to invest in new jobs. All they seem to want to do is invest to eliminate jobs. Is there any mystery here? It is government policy that has turned job creation into a dicey investment.

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  9. Probably worth looking at this in light of Stephen Williamson's latest entry. Real GDP right now is either at trend (according to H-P filter, US trend growth rate now is about zero!) or 15% below trend, using a linear trend of last 100 years.
    Something very dramatic is going on with the US economy, and as Steve says, we'd better damn well figure it out.

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  10. You say "Frictional unemployment, which is a function of search costs, most likely hasn't changed that much."

    But surely mobility costs are part of frictional unemployment and, with so much of the population (especially the unemployed population) stuck in underwater houses, mobility costs, and thus frictional unemployment, have significantly increased in recent years.

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  11. Long-term, structural unemployment is real and is here to stay. Even those economists who are beginning to recognize the problem vastly underestimate the ultimate impact. It is not just about a "skill mismatch." It is ultimately going to be about a total lack of demand for skills (and workers). It is something unprecidented and it is caused by advancing technology. And ,no, it is NOT the same thing that has been going on for decades. Technology is moving faster and faster. In the next couple of decades will will see a staggering level of progress.

    For an excellent overview of this problem, check out this book (available as a free PDF): The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future. http://www.thelightsinthetunnel.com).

    If there were a textbook on this issue of technological unemployment and where it will lead, this book is it. I wish every economist would take a break from data analysis and READ THIS BOOK.

    The author also has a blog at http://econfuture.wordpress.com

    ReplyDelete