Friday, August 27, 2010

What About the Recovery?

Let's go through this morning's Krugman NYT column.

First point:
The important question is whether growth is fast enough to bring down sky-high unemployment.
It's not that simple. Clearly, particularly given the downward revision of second-quarter real GDP growth from 2.4% to 1.6%, it will take a very long time (see here) for the US economy to return to its long-run growth path, if it ever does. If we think that, at the point where we're back on the long-run growth path, the US economy looks like it did before the recession, this tells us we have high unemployment for a very long time. However, one interpretation of recent evidence on the unemployment/vacancies relationship (see here) is that there is an unusual degree of mismatch in the labor market - the unemployed don't live in the places where the vacancies are, and may not have skills that match well with what firms want. As further evidence, look at labor market behavior in Canada, where the real GDP path through the recession is fairly similar (though the recovery is somewhat stronger). In the US, our mismatch problem is not only making the unemployment rate high - it's making GDP low. How long this matching process takes to work itself out, or what policy might do about it are questions I hope people (who know more than I do about labor markets) are studying.

After its last monetary policy meeting, the Fed released a statement declaring that it “anticipates a gradual return to higher levels of resource utilization” — Fedspeak for falling unemployment. Nothing in the data supports that kind of optimism.
What's in the Fed statement is pretty bland. They're hardly sticking their necks out, and I wouldn't call it "optimistic." It's rather bold to say there is nothing in the data that could support what they are saying.

Now, we know where this is going.
Why are people who know better sugar-coating economic reality? The answer, I’m sorry to say, is that it’s all about evading responsibility.

So what should officials be doing, aside from telling the truth about the economy?
Note that, Ben Bernanke. Krugman just called you a liar.

We'll stick to the monetary policy part. Krugman's recommendation is:
The Fed has a number of options. It can buy more long-term and private debt; it can push down long-term interest rates by announcing its intention to keep short-term rates low; it can raise its medium-term target for inflation, making it less attractive for businesses to simply sit on their cash.
(i) The Fed's portfolio of Treasuries already consists mainly of long-maturity debt. If the Fed bought more, it would simply be swapping reserves for long-maturity Treasuries. As the system is already swamped with reserves, this would do essentially nothing. (ii) The Fed is currently holding in excess of $1 trillion of mortgage-backed securities. This purchase of private assets was controversial, as it threatens the Fed's independence, and the public perception of its role. While one might make a case for such an intervention on emergency grounds, this should not be considered a standard instrument in the Fed's toolbox. Further, at best this type of intervention simply replaces private intermediation with Fed intermediation, and at worst it reallocates credit from productive investment to housing. (iii) The Fed has already announced (over and over) its intention to keep rates low "for an extended period." What more can they do? (iv) Raising the "medium term target for inflation" is redundant. The Fed has to take some action - buying or selling some class of assets, or changing the interest rate on reserves - or announce future actions, to effect a change in the inflation rate. We've already covered all of that stuff.

Here's a fiscal policy recommendation:
It [the administration] can use Fannie Mae and Freddie Mac, the government-sponsored lenders, to engineer mortgage refinancing that puts money in the hands of American families
Remember how we got into this mess? Fannie and Freddie are not the solution to anything. They are a big part of the problem.

It’s time to admit that what we have now isn’t a recovery, and do whatever we can to change that situation.
Well, it certainly does stink, especially if you are unemployed. However, on the monetary policy front, the Fed has already pulled out all the stops, and done whatever it can do, in an unprecedented fashion. This is one of those cases where you just can't squeeze blood from a stone, and that's true in more ways than one.


  1. Let's hear the opinion of the person who has the most power today to act on unemployment and mismatch, Ben Bernanke.

    This is from his 2008 Macroeconomic text (with Andrew Abel and Dean Croushore):

    It seems clear that increased mismatches between workers and jobs can't account for all the increase in unemployment that occurs during recessions. Much of that increase is in the form of temporary layoffs; rather than search for new jobs, many workers who are temporarily laid off simply wait until they are called back by their old firm. Moreover, if recessions were times of increased mismatch in the labor market, more postings of vacancies and help wanted ads during recessions would be expected; in fact, both vacancies and new job openings fall in recessions. (page 376)

  2. "Moreover, if recessions were times of increased mismatch in the labor market, more postings of vacancies and help wanted ads during recessions would be expected; in fact, both vacancies and new job openings fall in recessions."

    That's exactly the point. The recent observations are different - that's the Beveridge curve shift.

  3. Murat Tasci and John Lindner:

    ' “During and after recessions in the postwar period, the Beveridge curve has generally followed a pattern of shifting to the right during a recovery. One potential reason for this could be that even though some unemployed workers start filling the available job openings, workers who had left the labor force might get encouraged by the recovery and start looking for a job, thereby keeping the unemployment high.”

    P.S. Please note the last graph.'
    h/t Mark A. Sadowski

  4. Have a look at the recent behavior of the participation rate.