Slow recovery in the labour market
27 July 2009 - Slow recovery in the labour market
The unemployment situation in the United States is quite dismal, and it is pretty awful just about everywhere else too. The global economy is experiencing its worst growth performance in sixty years and the effects are evident in the all-important labour market.
One reason why earnings, in the current reporting season, are turning out to be better than expected is that firms have taken a tough line on cost containment. And that means smaller salary increases, actual pay cuts, firing or caps on hiring.
These measures obviously affect total employment compensation, which constitutes a very large part of personal income. As for the other main categories of household income, namely receipts on assets, proprietors’ revenues, rental income, and net transfer receipts, it is the last item that has been helping to sustain household spending.
This is, of course, the intended objective of government policy, via massive stimulus packages. Clearly, if governments had not stepped in to help, then households would have cut back on spending even more drastically, with nasty negative multiplier effects on the whole economy.
In the US, for example, the rising household savings rate is counterbalanced by substantial dissaving in the public sector. Consumers are trying to reduce their debts while the government is accumulating a huge debt load. This is a necessary consequence of trying to prevent rapid adjustments in the economy and avoid the occurrence of a very severe recession.
The government has succeeded in achieving that goal but at the cost of stretching out the adjustment process in the economy over a longer period. And in due course, the exit strategy from the aberrant fiscal policy may be a difficult one to engineer. Many investors, particularly in the bond market, are already looking further ahead and sniffing the scent of possible trouble.
The scale of job losses in the US has been substantial and has occurred with great rapidity. Since the start of the recession, nearly all the employment gains in the previous expansion have already been wiped out, and the losses continue. What’s more, the unemployment rate underestimates the extent of stress and underemployment in the economy.
There are hordes of discouraged workers who have dropped out of the labour force by giving up on searching. In addition, there are many employees who have been asked to take unpaid leave. These two categories do not show up in the official data releases that feature in headline news. Including them in the statistics would bump up the reported unemployment rate considerably.
Meanwhile, the length of time that people remain unemployed has increased. Worst of all, there will be a large number of unemployment-insurance recipients whose standard benefits will soon expire. If employment conditions do not improve, they will be left with reduced access to benefits and few prospects of getting a job.
At the same time, many state budgets are bleeding in a bright red colour, and some of them need hospitalisation. The states have been depleting the allocations they got from the federal government stimulus package at a rapid pace. But running a balanced budget in current circumstances would exacerbate the difficult economic conditions.
All the signs are that employment conditions will be slow to improve, which means that there will be rising political pressure on the government to bring in additional stimulus measures to relieve unemployment and to prevent the economy from sliding back into negative growth. Governments in other countries may also have to face up to demands for action.
As for monetary policy, any thought that the Fed is vigilant on inflation and ready to undo quantitative easing and raise interest rates in a proactive manner should be firmly dismissed. It is far more likely that they will wait long to ensure that the recovery is firmly entrenched before implementing tightening measures.
Fear of falling back into recession will ensure that expansionary monetary and fiscal policies will be maintained for a longer period than cautious policymaking would normally permit. This means that, in terms of policy tradeoffs, authorities are willing to risk higher inflation.
Of course, they will be seeking justification and making the comforting argument that the output gap is so large that inflation is a distant and containable threat. Unfortunately, the severity of the recession has undoubtedly reduced capacity, which means that current estimates of the output gap are probably overestimating its size.