Everything that needs to be said has already been said.
But since no one was listening, everything must be said again.

Andre Gide


Wednesday, December 31, 2014

Brad DeLong on the Employment-to-Population Rate

Brad DeLong offers his musing here on the U.S. employment-to-population rate. As a rough control for demographic factors, he focuses on prime-age workers--those aged between 25-54. And he decomposes prime-age workers by sex. I like this exercise. In fact I've looked at the same data in an earlier post here, making comparisons with Canada. 

DeLong normalizes the E-P rate for males and females to zero in the year 2000. For both sexes, the E-P rate is roughly 5% lower than in 2000. Here is his graph:


In reference to this data, DeLong asks a few questions. Heck, it's the end of the year and I'm in the mood to answer some of them.
(1) If the US economy were operating at its productive potential, the share of 25 to 54-year-olds who are employed ought to be what it was at the start of 2000. Back then there were few visible pressures leading to rising inflation in the economy.
Does anybody disagree with that?
I'm not sure, so I think I'll disagree. It's very hard, I think, to know precisely what constitutes "productive potential." And the use of the word "potential" leads us (possibly incorrectly) to interpret the deviations in the graph above as "cyclical" (mean-reverting) fluctuations. I think that some of the decline in the male E-P rate can be reasonably thought of as being "below potential." I base my assessment on this graph (which I plotted a year ago and uses the 16+ population as a base):


This longer time-series shows a modest secular decline in the E-P ratio in both the U.S. and Canada since 1976. Personally, I think it's unlikely that the local peak in 2000 represents some magical measure of "potential." My hunch is that there are "structural" factors at play here including, but not limited to, things like rising disability rates. Having said this, I also don't believe that the male E-P rate has fully recovered. As I've mentioned before, the current dynamic resembles very much what Canada went through in the 1990s, i.e.,


The idea that the female E-P ratio is far below "potential" is even more misleading, I think. There's something strange going on with U.S. female employment relative to other advanced countries (all which resemble Canada in the diagram below).


Again, it's likely that a part of the post-2008 decline is cyclical. But its even more likely that most of the decline is structural (e.g., changing maternity leave benefits, etc.). My own feeling is that structural issues are better tackled through fiscal (or labor market) policies--not monetary policy.
(3) Even if you think–in spite of the absence of accelerating inflation–that employment in 2000 was above the economy’s long-term sustainable potential, there is no reason to believe that a U.S. economy firing on all cylinders would not have 25-54 employment to population rates–both male and female–back at their 2006 levels, a full 3%-age points–and 4%, 1/25–higher than today.
Does anybody disagree with that?
I'm not going to disagree with this.
(4) The U.S. economy’s convergence towards its potential is very slow: The 25-54 employment-to-population ratio has only risen by 1%-point over the past two years.
Does anybody disagree with that?
I'm not going to disagree with this either. However, my interpretation of this phenomenon is a "structural" one, which I explain here (see also here).
(5) Yet in spite of all these, the Federal Reserve believes that the U.S. economy is now close enough to its productive potential that unless some more things go wrong it is no longer appropriate for it to be buying assets and it will be appropriate for it in a year to start raising interest rates even though inflation is still below its 2%/year target.
Well, I'm not speaking for the Fed here (and remember, there are divergent views within the FOMC), but the consensus view seems to be that inflation is just "temporarily" below target. And the recent FOMC statement makes clear that any rate hike will be made contingent on the incoming data. Moreover, even if a rate hike is in the making, it is likely (in my view) to be described as progressing at a "measured pace," similar to the way it was in 2004.
The only way to square (1) through (4) with (5) is if the Greater Crash of 2008-2009 and the still-ongoing Lesser Depression really have pushed between 2 and 4%-age points of our 25 to 54-year-olds out of the labor force permanently, so that we can never get them back, or at least never get them back without an economy at such high pressure to produce inflation that the Federal Reserve regards as unacceptable.
Yes, I suppose this is just another way of saying that a major component of the decline in the E-P rates reported above are attributable to "structural" factors that are better dealt with (if at all) with fiscal policy.
This may be true.
But it does raise two questions: 
[1] What has made the Federal Reserve so confident that it is true that it is willing to make policy based on it–especially as current inflation is still below the 2%/year target?
Again, I am not speaking for the Fed here. But one argument I often hear is that additions to the Fed's balance sheet have not been very effective, especially in terms of improving the labor market. At the same time, people have expressed some degree of nervousness over "not knowing what they don't know" about operating with such a large balance sheet. The Fed is charting new territory here. The benefits seem small at best, and the risks are not fully known. There is some concern that a low-rate policy may induce a "reaching for yield phenomena," leading to financial instability.

Yes, inflation is still below the 2% target, but not that much below. Does a 1.5% inflation rate warrant a policy rate of 25 basis points? Historical Taylor rules evidently suggest that a higher (but still low) policy rate is desirable in the present circumstances. (Note, once again, this is not necessarily my own view.)
[2] If it is true that the missing 2 to 4%-age points of 25 to 54-year-olds now out of the labor force could not be pulled back in without allowing inflation to rise above it’s 2%/year target, isn’t that an argument for raising the 2%/year target rather than accepting the current 77% 25-54 employment to population ratio as the economy’s limit of potential?
No, I don't think raising the long-run inflation target (to say 3% or 4%) will have any measurable long-run impact on the labor market. A significantly higher inflation tax may even discourage employment (the long-run Philips curve may be positively sloped). If there are things that need "fixing" in the labor market six years into the recovery, they are probably better dealt with directly through labor market policies (like improved maternity leave benefits) or fiscal policies (tax cuts, wage/training subsidies, etc.)

***
Some background reading: Many Moving Parts: A Look Inside the U.S. Labor Market.

Thursday, December 18, 2014

Considerable Time and Patience a Decade Ago

According to USA Today:
Wall Street cheered as the Federal Reserve used a new word — "patient" — to basically let the market know that it isn't in a rush to hike short-term rates next year.
So, "patient" is the new buzzword. In other words, the Fed evidently ran out of patience with "considerable time." 

But just how new are these buzzwords? They're not new at all. Consider this from the December 09, 2003 FOMC statement, for example.
However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.
This "considerable period" language was also used in the August 12, September 16, and October 28 FOMC statements leading up to the December statement. The FF target rate at that time was 1%. Headline PCE inflation was running at about 2% (year-over-year), and the unemployment rate was about 5.5%.

Then, at the next FOMC meeting, the Fed switched from "considerable period" to "patient." From the January 28, 2004 FOMC statement
With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
Note that "inflation quite low" in January 2004 was 2%. The FOMC continued to express "patience" in its March 16 statement. In its May 4 statement, "patience" was replaced with:
At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.
Note that the "with inflation still low" statement now corresponds to PCE inflation running around 2.5%. 

It wasn't until the June 30 statement that the FOMC finally raised the FF target rate by 1/4%. And for the next 17 meetings, the FOMC raised its policy rate by 25 basis points. 

Should the Fed at that time exhibited less patience, both in the the timing and pace of "lift off?" Certainly John Taylor seems to think so

And what about the situation today? While the unemployment rate today (5.8%) is not far from where it was eleven years ago, the policy rate is at 1/4% (instead of 1%) and the PCE inflation rate is at 1.5% (instead of 2%). At the risk of oversimplifying, there are basically two views on the matter.

The dovish argument is that with inflation and inflation expectations low (relative to target) and unemployment still elevated somewhat, keeping the policy rate at its floor seems like the right thing to do right now. What this has to do with "considerable time" or "patience," I'm not sure. It is a state-contingent policy. (Adding "considerable time" or "patience" to the statement simply reveals the FOMC's own assessment of the probabilities associated with future states of the world.)

The hawkish argument is that the real economy is basically back to normal, that while inflation and inflation expectations are currently low, this is largely transitory. And in any case, the welfare cost/benefit of 1.5% inflation vs. 2% inflation is virtually nil. So, with inflation and unemployment at close to normal levels, why shouldn't the policy rate also start moving closer to normal levels? (There are also other concerns relating to low interest rates and financial instability--look at what happened the last time we had a "patient" Fed.) 

Stay tuned, folks.