This week, the U.S. federal government shut down after Congress failed to pass a continuing resolution on funding for the next fiscal year, and current negotiations (as of 12 p.m. this afternoon) appear to be leading both political parties nowhere closer to a solution. Without delving into the specifics, the broad disagreement centers on the size of the budget and impact of fiscal policy. So far this year, we have seen vigorous debates on debt-to-GDP ratios (see Reinhart and Rogoff’s error) and the effects of stimulus (see IMF staff paper), but there is no sure consensus among Congress on the best way for the government to help our economy move along at a faster clip. Should we spend more (Democrats), tax less (Republicans), or neither (the status quo)?
Nonetheless, despite not seeing eye-to-eye on taxes, spending, or the budget, Democrats and Republicans are in agreement on one issue: America needs more jobs. And stat.
In September 2008, Lehman Brothers, an investment bank, went bankrupt. The company’s failure kicked off a financial panic that pushed the economy into a terrible recession, costing nearly 9 million jobs. Since then, GDP has rebounded from its pre-recession peak (see the blue line in chart above), but total non-farm payrolls are still below where they were in late 2007 (see red line). America is producing, in real terms, more than it was six years ago, but with fewer people in the workforce. Economists and pundits have termed this phenomenon a "jobless recovery."
Why does a jobless recovery happen? The typical pattern for American recessions is the deep-V, a sharp downturn followed by a quick recovery in which the output and jobs lost are soon back. But something changed with the early 1990s recession, and subsequent recessions have included persistence in unemployment, despite recoveries in economic activity. A recent paper presented at Brookings Institution takes a look at the issue with some surprising findings.
First, the financial crisis did not systematically lead to longer unemployment when compared to other historical shocks (notably the monetary policy shock under Paul Volcker in the early 1980s). Second, declines in labor mobility (fewer people willing to move from a lost job in Kansas City to a new one in Dallas) and an aging population are not statistically significant factors. Third, social attitudes in America, particularly the willingness to go on disability insurance for longer, accounts for some of the change, but is offset in aggregate by demographics.
So what’s the deal? More research into the underlying factors at work is a central task for economists going forward. But more importantly, the paper suggests that if GDP has recovered to its pre-recession peak but the labor market is still weak, tightening fiscal and monetary policy is not the best course of action. But that is exactly what has happened to fiscal policy since 2008, and is a point of contention buried under this week’s debate about Obamacare, taxes, spending, and big government.
The FOMC (the policy committee of the Federal Reserve) announced in its September statement that it would continue without change to its asset purchases, also known as Quantitative Easing (“QE”). Why? One reason is that the Fed is “taking into account the extent of federal fiscal retrenchment," which is hurting economic growth. That is FedSpeak for, 1) the fiscal cliff drama was stupid, 2) the sequester was a stupid compromise, 3) if the government shuts down in disagreement, that will be really stupid, and 4) if Congress fails to raise the debt ceiling, that will be really, really stupid.
Congress is forcing the Fed’s hand in its monetary policy decisions, because as fiscal policy gets tighter, the answer is most definitely not for monetary policy to tighten as well. That would, as the Brookings paper suggest, only prolong the current issue of a jobless recovery. But accommodative monetary policy, particularly QE, is something that Congress loathes. Why? Congress says the darndest two things: QE will lead to crippling inflation (it hasn’t and won’t so long as America is running below capacity), and QE distorts capital allocation and boosts asset prices artificially (so….is that more or less of a concern than allowing the long-term unemployed to become even more unemployable?).
As long as Congress remains intransigent, the Fed will likely not taper its asset purchases, and thus we are in store for a vicious cycle (Congress tightens fiscal policy, the Fed remains accommodative, Congress complains about the Fed, and repeat). We have heard arguments from Congress this week that Obamacare is killing the economy, that government needs to get out of the way, and that our country’s debt addiction must end. This is hyperbole and a distraction. Congress has hurt the recovery in its partisan misunderstanding of how fiscal policy, following a financial crisis and deep recession, must step in for a collapse of private demand to help Americans avoid suffering through a jobless recovery. The opposite only makes things worse.
Oh, and this article doesn’t even delve into the fact that in a few weeks, Congress might push the country into uncharted territory: a voluntary default on our sovereign debt. Happy October.