By the time I awake tomorrow, Kash is likely to have posted the employment report for the first month of this year. For reasons noted below, I’m HOPING employment increases a lot this month and every month for the year. Hoping but not forecasting.
Greg Mankiw of the CEA is forecasting employment growth of only 1.5% for this year, which is likely a reasonable estimate given that most forecasters are predicting real GDP growth that is not much greater than the growth in potential output.
Roger Ferguson of the Philly FED (via Brad DeLong) is suggesting that some of the decline in labor force participation may be voluntary. As Greg Ip and Kemba Dunham of the Wall Street Journal reported, Mr. Ferguson is giving a fair and balanced view of the state of the labor market:
If indeed there is less readily available labor than previously thought, Mr. Ferguson said, “the amount of economic slack could be very small, and thus expansive monetary policy could lead to a pickup in inflationary pressures. That need not be the case, he added: “A substantial pool of unused labor may remain in the labor market, and an overly restrictive monetary policy could” slow the return to full employment. “The evidence is more ambiguous than one would like,” Mr. Ferguson said. Still, Fed officials appear to believe there remains a lot of slack in the labor market, even if it is less than they thought. The main evidence is that wage growth remains subdued.
As we discussed here, Julie L. Hotchkiss of the Atlanta FED also noted that part of the decline in labor force participation may have been voluntary, while part of it represented the discouraged worker effect (link to her paper).
But we also noted how Lawrence Kudlow misrepresented her paper. As I think about the very good discussions from the Federal Reserve – including some of their recent optimism about short-term employment growth – the following words from Kudlow really trouble me:
With this [Hotchkiss] study in mind, it is possible that this year’s unemployment rate could dip below 5 percent.
While Mankiw and Kudlow often emphasize the unemployment rate, I prefer to look at the employment-population ratio. And there is a big difference between what Dr. Mankiw is forecasting and what Mr. Kudlow seems to be hoping for. Let me explain using the following table of the employment-population (EPR) ratio, the labor force participation rate (LFP), and the unemployment rate (UNR) for April 2000, December 2004, and December 2005 under three hypothetical scenarios.
12/2005-a represents my best guess as to what the CEA is forecasting. It assumes employment as measured by the Household Survey increases from 140.156 million to 142.258 million (1.5%) and population grows by 1.3% from 224.64 million to 227.56 million. It also assumes that LFP stays constant at 66.0%. Kudlow’s oped seems to be suggesting the same very modest rise in employment, while he is praying for an increase in the number of discouraged workers. Yes, we would have a 5% unemployment rate if LFP happens to fall even further to 65.8%. But why would that be a good thing? In fact, the average level of labor force participation over the 1989 to 2004 period (which included two recessions) exceeded 66.5%. If LFP = 66.5%, the CEA forecast for employment growth would be consistent with an unemployment rate of 6%.
The last column is my wish list and not a forecast. I would hope we would have greater aggregate demand growth so that employment might rise by 3.9% rather than only 1.5%. In this case, it would be possible to see both a rise in LFP (say to 67%) and a fall in the unemployment rate (say 4.5%). Of course, Mr. Ferguson might reasonably ask how much excess supply currently exists.
If Mr. Kudlow really believes in his measure of potential GDP used when he excused the Bush deficits in his The Deficit Dance, then he should agree that my wish list for the labor market is reasonable. OK, his suggestion that we had a $2 trillion GDP gap was just stupid math – even though this is how he claimed the recession was the only reason we had a deficit (a bogus claim based on bad math repeated by Robert Novak on Capital Gang). But let’s take his assumptions, which seem to be: (a) the economy was exactly at full employment in mid-2000, (b) potential GDP grows by 0.85% per quarter, and (c) real GDP will grow by about 1% per quarter for 2004Q4 and throughout 2005. This would suggest real GDP (2000$) would be $11,447 billion at the end of 2005 while potential GDP would be $11,864 million. So Kudlow seems to be praying for continuation of excess supply and a weak labor market so that it will be a discouraged worker effect that will give the appearance of a lower unemployment rate. Too bad – the Bush cheerleaders at the National Review are not praying for a more vigorous aggregate demand policy from this White House. But maybe they know what Dr. Mankiw knows – this is not on the President’s agenda.