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Saturday, September 18, 2010

The trouble of unemployment

In my intro macro class, I teach about unemployment and of course I teach using the severely limited tools of AD-AS model and Keynesian cross etc.... Such models would have students believe that reducing our current cyclical unemployment now at 9.6% is just a factor of 2 things that need to happen:

 *Allowing for inventories to properly readjust and for spending to get back to 'equilibrium' with production.
 *Allowing for prices and wages to properly readjust to allow for supply and demand to get back to 'equilibrium' with respect to 'full' employment of resources

Now, such insights are useful.  We in fact did need to have an inventory realignment (as well as a financial-sector realignment).   And indeed, the state of our financial sector and of our production levels have bounced back to a significant degree.  The second insight regarding prices and wages have taken hold as well.  Prices have stagnated for many quarters, as have wages.

So the question is, why hasn't employment bounced back?  Theory would have us all believe that producers would bounce back as input costs are low and as the economy improves and they would regain hiring.  There are a few flaws in the real world however that make this not a very useful observation:

1.  Producers don't make decisions largely based on present conditions, but rather they make decisions based on future conditions (of profits, of interest, of prices, etc).

2.  Not all recessions are the same:  many of our recent recessions did not require significant shifts in the makeup of our industries.  This recession has meant a complete retooling of our industries (our manufacturing is becoming 'greener', our financial industry is re-making itself, etc).  This retooling means significant increases in structural unemployment which necessarily means we will maintain this rate of unemployment for a significantly long period of time.

Further, this recession has been met with conflicting answers:  the private sector's answer has been to become more conservative, to do more with less, to increase productivity of the average worker while maintaining less workers.  The public sector's answer (our government) has been to spend, and spend some more, in hopes to rejuvenate the economy Keynesian style.   Whenever the public and private sectors act in such diametrically opposed ways, it breeds uncertainty.  Add to this the government's schizophrenic message: let's spend money, but let's cut the deficit, let's create huge housing subsidies, and then let's take it away, let's extend unemployment, let's not extend unemployment.... Uncertainty means perceptions of the future (see point 1 above) will vary widely and all of that contributes to our present situation, where one month things look good (in the labor market and in the housing market) and the next it looks bleak.  Of course, none of this added uncertainty is good for the economy in the short or the long-run.

This brings me to my point(S):
1.  Textbook macro teachings regarding the relationship b/w spending-employment-production should be taken with a grain of salt by students (and teachers that don't point out the numerous assumptions in the models are doing the world a huge dis-service).

2.  The Obama administration has been a huge failure if for the only reason that it has lacked clear decisive message and vision.  I agreed with aspects of the stimulus, but much of it has been a huge failure both in terms of message and in terms of results for reasons I've discussed before.   The administration has helped breed uncertainty which is the last thing we need right now.  (Note:  that's  not to say Republicans would have been any better - they don't really even have any message of their own it seems).  I should caveat this point by saying that I don't think there's  much the government can do about this recession anyway given the structural nature of it, but the fact that he thought he could apply (poorly) old-school Keynesian methods and call it "change" and expect huge results is appalling to me.   I'm just as tired as the next guy of the old Keynesian response of throwing money at problems and hoping it sticks.   It never works.

3.  I don't expect the unemployment rate to budge, now, or much at all even next year.  I suspect we now have a structural unemployment problem that could last years (ie., I suspect our new 'full' employment rate is probably above 7% now).

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