Weekly Economic Commentary by Scott J. Brown, Ph.D.
November 25 – December 6
One of the main economic debates of the last few years has been whether weakness is cyclical or structural. If the downturn is due to a temporary (albeit, severe) shortfall in domestic demand, then growth should pick up sharply at some point as the economy returns to its potential. If it’s structural, fiscal and monetary policy can do little to help. Opinions differ, but while the consensus may see the sluggish economy as reflecting mostly cyclical forces, cyclical weakness is more likely to become structural the longer it lasts. Over time, some structural change will occur naturally, but it need not be too disruptive.
Since bottoming in 1Q09, real GDP rose about 10% through 3Q13. That works out to an annual rate of 2.1%. This pace would be nearly ideal if the economy were operating at full employment – but it’s not. The continued slack in the economy has a number of consequences. The typical worker is not seeing much in the way of real wage gains, which limits the pace of growth in consumer spending. More important, the longer this output gap remains elevated, the more likely that the path of potential GDP growth will be lowered.
Some (notably former Treasury Secretary Larry Summers) have suggested that the economy may need bubbles to return to its potential. Indeed, the previous decade was driven largely by the housing bubble, which helped fuel consumer spending growth through home equity extraction, rather than through growth in personal income. The previous bubble, the tech boom, facilitated a substantial gain in business fixed investment, but wealth effects were not as widespread as in the housing bubble, and the aftermath was nowhere near as severe.
During Alan Greenspan’s tenure as Fed chairman, the view was that the central bank should not even attempt to call a bubble, let alone try and deflate one. That opinion has changed following the collapse of the housing bubble.
Ideally, employment, consumer spending, business investment, bank lending, and foreign trade would all grow at nice sustainable rates, but that’s never going to happen in real life. Still, there’s no reason to believe that the economy has to have a bubble to reach its potential.
Manufacturing is one area that has experienced a lot of long-term structural change. For most of the last several decades, manufacturing employment has been more or less steady, falling some in recessions and rising back in recoveries. As a rule of thumb, the U.S. would lose about one out of ten factory jobs each year in the 1980s, but would see a new manufacturing job created in its place. The country shed low-productivity jobs and gained high-productivity jobs. Even though manufacturing employment was little changed, factory output rose sharply.
Something else happened in the last two recessions. Manufacturing jobs that were lost were not replaced by new ones. An expansion of foreign trade capacity was likely the culprit. China beefed up its export capabilities, while a larger class of container vessels combined with port expansions to generate a huge increase in U.S. imports. The leading U.S. export at the time? Empty containers back to China.
Some have forecasted a “renaissance” in U.S. manufacturing, but it’s not there yet in the data. The expansion of the Panama Canal (which will double capacity by 2015) and improvements in East Coast ports are likely to facilitate some growth in U.S. exports. Low energy costs will give U.S. firms a competitive advantage. However, most of the manufacturing returning to the U.S. will be capital intensive. So, we may see limited growth in manufacturing jobs over the next decade or two.
Structural change, such as increased foreign trade, will present opportunities as well as challenges. However, a continuation of the wide current account gap remains the biggest risk to long-term U.S. economic growth.
Yellen: “Farther To Go”
November 18 – November 22, 2013
Janet Yellen gave a balanced assessment of how monetary policy will be conducted during her tenure as Fed chair. However, the financial markets perceived a “dovish” tilt. She stressed that conditions in the labor market are still far from normal and noted that inflation has been running below the Fed’s goal of 2% “and is expected to do so for some time.” However, Yellen noted that there were risks of removing support too late as well as too soon. QE3 can’t go on forever.
Yellen: “Today the economy is significantly stronger and continues to improve. The private sector has created 7.8 million jobs since the post-crisis low for employment in 2010. Housing, which was at the center of the crisis, seems to have turned a corner – construction, home prices, and sales are up significantly. The auto industry has made an impressive comeback, with production and sales back to near their pre-crisis levels.”
“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential.”
In past speeches, Yellen has spoken emphatically about the need for improvement in the labor market. She was a major proponent of QE3 (which was meant to last until there was “substantial improvement” in labor market conditions). Labor market weakness has a significant impact on peoples’ lives, but is not just a problem for the individuals (and families) involved. The slackness in the labor market represents a loss of economic output and, if prolonged, will lead to lower potential growth.
As Chairman Bernanke noted, fiscal policy has been the main economic headwind this year. Yellen expressed encouragement that the economy has done as well as it has, noting that momentum would be building if not for the fiscal drag.
The Fed has a dual mandate: low, steady inflation and maximum sustainable employment. Yellen would not sacrifice one goal for the other. She is fully committed to Fed’s goal of 2% inflation. In fact, at the request of Chairman Bernanke, Yellen led the effort to adopt a statement of the Fed’s long-term objectives. The formal statement of the 2% inflation goal has helped to anchor inflation expectations.
It’s no secret that Yellen has also had a strong hand in both the asset purchase program (QE3) and the forward guidance (on short-term interest rates). In her testimony, Yellen said “I consider it imperative that we do what we can to promote a very strong recovery,” adding that the Fed is doing that through the continuation of its asset purchase program. The Fed needs to be aware of the risks, but Yellen said that “at this point, I think the benefits exceed the costs.” She added that there has been some reach for yields, but “we don’t see a broad build-up of leverage that, at this stage, poses a risk to financial stability.”
She said “it’s important not to remove support, especially when the recovery is fragile and the tools available to monetary policy, should the economy falter, are limited given that short-term interest rates are at zero.” It could be “costly” to remove accommodation too soon. “On the other hand,” she noted, “it will be important for us, as the recovery proceeds, to make sure that we do withdraw accommodation when the time has come.”
She declined to give specific guidance on what constituted “substantial improvement” in the labor market, adding that the asset purchase program is “not on a set course” and will remain data dependent. However, she also agreed that “this program cannot continue forever” and the longer it continues, the more the Fed will need to worry about the risks.
Surprise, Surprise, Surprise!
November 11 – November 15, 2013
The economic data were mostly stronger than anticipated last week. GDP growth exceeded expectations, although the details were a bit troublesome. With everyone anticipating some impact from the partial government shutdown, nonfarm payrolls accelerated in October. Moreover, revisions to August and September, painted a much stronger picture of job growth. What does this mean for the Fed and its decision to taper?
Golly! Real GDP rose at a 2.8% annual rate in the advance estimate for 3Q13, the strongest performance since 1Q12. However, consumer spending growth rose at a 1.5% pace and business fixed investment rose 1.6% – nothing to write home about. Residential home building continued to pick up; residential fixed investment added 0.4 percentage point to the headline GDP growth figure. Foreign trade added 0.3 percentage point (exports +0.6, imports -0.3). Government was about a wash, as a positive contribution from state and local government offset a negative contribution from the federal government (a theme that has also been reflected in the payroll figures). Inventories, which had risen at a relatively brisk pace in 2Q13, rose even faster. Recall that the change in inventories contributes to the level of GDP. So, the change in the change in inventories contributes to GDP growth. Faster inventory growth appears to have been unintentional, as domestic demand fell short of expectations. We’re almost certain to see slower inventory growth in 4Q13, which will subtract from GDP growth. There’s a major caveat to all this. The GDP figures will be revised on December 5 (and again on December 20).
The partial government shutdown had a mixed impact on the October employment figures. Bureau of Labor Statistics Commissioner Groshen indicated that “there were no discernible impacts” on the estimates of payrolls, hours, and earnings. However, there appear to be non-sampling errors in the household survey. Furloughed federal workers should have been classified as “unemployed on temporary layoff,” but many were apparently recorded as “employed, but absent from work.” The unemployment rate edged up only slightly (from 7.24% to 7.28%), but labor force participation fell by 0.4 percentage point, to 62.8%, while the employment/population ratio dipped by 0.3 percentage point, to 58.3%. The BLS reported that the labor force fell by 720,000, while employment dropped by 735,000, with 932,000 disappearing from the labor force. These are large numbers, reflective of the government shutdown, but don’t take them at face value. The household survey, which is based on a sample of about 60,000 households, generates unreliable estimates of levels (employment, unemployment). The estimate of the number of unemployed individuals, reported to have risen by 17,000 in October, is accurate to ±300,000. The household survey sample is, however, large enough to generate reasonable estimates of ratios, such as the unemployment rate (although that’s only accurate to ±0.2 percentage point).
Shazam! Nonfarm payrolls rose by 204,000 in October, with a net revision to August and September of +60,000. Private-sector payrolls have averaged a 190,000 monthly gain over the last three months – a higher trend than expected.
For Fed policymakers, the recent data paint a mixed picture of the economy. The labor market has improved significantly since the Fed began its asset purchase program, but is that enough? The better picture of payrolls implies that a December tapering in the pace of asset purchases is not out of the question, but the decision to taper, as Fed officials have explained repeatedly, will be data-dependent. There will be one more employment report before the December 17-18 Fed policy meeting, but the Fed will have a lot to consider besides jobs. Higher long-term interest rates and a low inflation trend will be important factors.
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