Fed policy: complicating an already complicated situation
by Rebecca Wilder
The Federal Open Market Committee (FOMC) is making tough decisions right now. Its mandate, “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”, is a seriously tall order given current economic conditions.
The unemployment rate sits at 9.7%, while prices have bounced back to 2.6% Y/Y in January. On the surface of it, inflation appears to be gaining some traction; but the big numbers are representative of base effects, and that is really all. The drag on prices remains very real.
But there is one little kink in the headline figures of unemployment that complicates an already complicated task: extended unemployment insurance. From the FOMC’s Jan. 26-27 minutes:
Though participants agreed there was considerable slack in resource utilization, their judgments about the degree of slack varied. The several extensions of emergency unemployment insurance benefits appeared to have raised the measured unemployment rate, relative to levels recorded in past downturns, by encouraging some who have lost their jobs to remain in the labor force. If that effect were large–some estimates suggested it could account for 1 percentage point or more of the increase in the unemployment rate during this recession–then the reported unemployment rate might be overstating the amount of slack in resource utilization relative to past periods of high unemployment.
Why would extended unemployment benefits increase the unemployment rate? In order to claim unemployment benefits, one must be “in the labor force”; and that means looking for work. Therefore, some workers who would otherwise be classified as “not in the labor force” remain in the work force as “unemployed”. Therefore, the current unemployment rate is elevated above the rate that would occur without the extended benefits. The Fed suggests this differential to be roughly 1% point.
I am in no way proposing that the extended benefits be rescinded; nor am I deluding myself into thinking that the labor market is anything short of awful. But Fed policy is calibrated to the non-inflation-generating level of the unemployment rate. And the current unemployment rate may be closer to the long-run level than the headline number suggests.
I have talked about this before (see this post) from another angle: the long-run level of unemployment may be a moving target right now, i.e., it’s likely rising. Therefore, if the long-run level of unemployment is rising and subsidies are masking the true level of the current unemployment rate, then we may very well get some inflation while the economy is still weak.
Of course, I do not believe that we are even near such a threshold level; but it does complicate an already complicated situation. A modified Taylor rule demonstrates the implications for policy.
The chart above illustrates the estimated Taylor Rule using the current unemployment rate (in blue line) versus one in which 1% point is shaved off the unemployment rate for every month since January 2008 (green line). The modified rule does suggest that the Fed policy rate is currently at (or now below) the prescribed rate.
Just some food for thought. Rebeca Wilder crossposted with Newsneconomics
If unemployment compensation is having the claimed impact why is the participation rate plunging as it is.
I would think feb members would be better analysts than this.
Maybe not all workers are eligible for Unemployment when they are laid off? In which case they fall out of the Civilian Labor Force and into Not In Labor Force.
What the Fed is suggesting is what I would believe to be a tautology. Unemployment Rate is high because of Unemployment Compensation. To decrease Unemployment Rate, cut Unemployment Benefits.
Didn’t Larry Summers make a similar argument? But the issue is not Unemployment Rate which is symptomatic of the root cause . . . lack of jobs and a decreasing job creation rate since 2001. Maybe I am not clear on this. Is the Fed suggesting they need to lower Unemployment Rate by cutting Unemployment Compensation; in which case, the Fed can then increase the Fed Rate to a normal level?
I would think the Fed and Benanke are more politically motivated and aligned with Wall Street than analysts. Masters of the superficial.
To claim Unemployment you typically have to show and document if necessary that you are actively seeking work and so should be considered part of the labor pool. Failure to claim is thus scored as an exit from the labor force and so a decrease in unemployment, you not being unemployed if you are not looking for a job.
Now in reality people who run out of UI benefit eligibility by and large really would like a job, given that the possible alternative of being homeless and hungry not being that attractive, it just is the case that an extension of unemployment will arithmetically increase the unemployment rate by the exact amount of people not dropped from the rolls.
Though of course you have to be pretty heartless to suggest cutting the unemployment rate by moving people over to the welfare rolls, but if your goal is just to move the index by a few tenths of a percentage point, that is exactly what a benefit cut would do.
I haven’t done the math lately, but I think you’ll find the ratio of U-6 to U-3 pretty much in line with its historical figure: roughly, the U-3 is 55% of U-6. That historical ratio would seem to belie this whole line of analysis, which should see the U-3 to U-6 ratio grow higher than normal.
***the possible alternative of being homeless and hungry not being that attractive***
Utter nonsense. The Economists at the University of Chicago have demonstrated conclusively that the US labor force is bone lazy and prefers homelessness and hunger to honest labor.
U3 is the “official unemployment rate” according to the BLS website. Due to this, it is the current measure of Unemployment that gets focused upon by most media, and therefore the public. It has, over the years, slowly excluded many of the factors that USED to go into how the US reported unemployment. Hence, there has been a gradual decrease in the Unemployment rate that has occurred regardless of what was happening in the Jobs market.
U3 is now comprised in a way that merely repeating it without a slew of caveats borders on fraud.
U6, on the other hand, is the broadest measure of Unemployment: It includes those people counted by U3, plus marginally attached workers (not looking, but want and are available for a job and have looked for work sometime in the recent past), as well as Persons employed part time for economic reasons (they want and are available for full-time work but have had to settle for a part-time schedule).
To be honest, I do not know what the true Unemployment rate actually is; I believe it is considerably higher than U3 (by 100s of basis points), but I suspect it might be lower than U6.
Not really the issue of what is measured by U3 or U6. The measure is what is measured and not measured. Laurent’s chart shows 1 in 5 males between 25 and 54 being unemployed or inactive. I suspct the measurement is much greatewr for other groups <18, etc also than what is reflected by U3 or U6.
The “Us” are erroneous and do not reflect reality.