The Credibility Gap of Economic Policy and Unavailability of Jobs

The Credibility Gap of Economic Policy and Unavailability of Jobs

Carlos M. Pelaez

This post analyzes the unavailability of jobs in (I), relating it to three policy credibility gaps: (IIA) fiscal policy, (IIB) monetary policy and (IIC) regulation. Economic indicators are considered in (III), financial turbulence in (IV), interest rates in (V) and the conclusion in (VI). If you have difficulty in viewing the tables and illustrations go to: http://cmpassocregulationblog.blogspot.com/

I Unavailability of Jobs. Indicators of job availability show significant stress in the United States. The number of employed persons in Aug 2009 was 139.433 million, declining to 139.250 million in Aug 10 or 183 thousand fewer people employed (http://www.bls.gov/news.release/pdf/empsit.pdf ). The relative availability of jobs is measured by the employment/population ratio, or percent of the civilian labor force to the civilian noninstitutional population in working age, that has declined from 59.1 percent in Aug 2009 to 58.5 percent in Aug 2010. The mediocre recovery of economic activity after four quarters of growth of GDP has been accompanied by fewer people in working age with jobs. Another measurement is the calculation of people in job stress, which has declined by only 0.9 percent in the 12 months ending in Aug 2010. There were 26.340 million people in job stress in Aug 2009 composed of: 14.993 million unemployed, 9.077 million working part-time because they could not find any other occupation and 2.270 million marginally attached to the labor force. In Aug 2010, there were 26.090 million people in job stress composed of 14.860 million unemployed, 8.860 million working part time because they could not find another occupation and 2.370 million marginally attached to the labor force.

The proper reference for comparison of employment during recovery from the current recession is with the recession of the early 1980s. Both recessions were severe in magnitude and in both cases misleading comparisons have been made relative to the Great Depression (for review of the Great Depression see Pelaez and Pelaez, Regulation of Banks and Finance, 198-217, and Globalization and the State, Vol. II, 205-9). The largest banks in the US in the 1980s, called money center banks because of buying money to lend by issuing certificates of deposit and borrowing short-dated bank reserves from smaller regional and local banks, had exposures to emerging markets that grew rapidly in the 1970s to finance balance of payments deficits originating in oil price increases. The fed funds rate for loans of reserves among banks rose from 9.61 percent in Aug 1980 to 19.08 percent in Jan 1981 and the rate on the six-month certificate of deposit reached 17.98 percent in Aug 1981 (http://www.federalreserve.gov/releases/h15/data.htm ). The increase in interest rates by the Fed in the US to break rising inflation forced foreign debtors of US banks into debt moratorium. If US banks had marked loans to an observable market value, the largest US banks, with the exception of Morgan Guaranty, would have had negative capital. In the meetings of the Federal Open Market Committee (FOMC) in 1983, then Chairman Paul Volcker remarked, with the advice “that comment doesn’t go in this report [that] there is a rising sense of nervousness underneath the surface and I think a lot of it is related to the perception that Brazil is not doing very well. If they need more money, they are out of compliance with the [International Monetary Fund requirements. They] must be able to make a Fund drawing on May 31 and aren’t going to be able to make it through. There is some feeling that the Brazilians may not be the most avid people in the world in following through on the strong program” (Paul Volcker, Meetings of the Federal Open Market Committee, May 24, 1983, 4, cited in Pelaez and Pelaez, International Financial Architecture, 181-2, 324, 337). Brazil did adjust remarkably, reducing the current account deficit from $16.8 billion in 1982 to $6.8 billion in 1983 and nil in 1984. GDP grew at 0.8 percent in 1982, fell by 2.9 percent in 1983 and grew by 5.4 percent in 1984 (Ibid, 182). Banks borrowed short-dated funds to lend long-term loans especially borrowing with short-dated savings deposits to lend 30-year mortgages. The increase in rates of short-dated funds raised funding costs while revenue from fixed-rate mortgages was unchanged, causing unbearable losses in banks. In 1983-90, 1150 commercial and savings banks, about 8 percent of the industry in 1980, failed, and 900 savings and loans, or about 25 percent of the industry, were closed, merged or placed in conservatorship by federal agencies. The cost to taxpayers of resolving insolvent savings and loans amounted to $150 billion (George Benston and George Kaufman cited in Financial Regulation after the Global Recession, 56), which was about 2.6 percent of 1990 GDP equivalent to $367 billion of 2009 GDP. The Congressional Budget Office estimates that in mid February 2010 the capital purchases and other support for financial institutions of the Troubled Asset Relief Program (TARP)had resulted in a net gain of $2 billion to the government(https://www.cbo.gov/ftpdocs/112xx/doc11227/03-17-TARP.pdf), that is, a gain to taxpayers instead of the loss to taxpayers of $367 billion from the banking crisis of the 1980s. In the upswing after the recession of 1979-82, the employment ratio jumped from 57 to 63 percent in 1990. The policy shift currently requires focus on promoting the proper incentives for rapid job creation by the private sector (Henry Olsen in the Wall Street Journal http://professional.wsj.com/article/SB10001424052748704388504575419280283794598.html ). Table 1 provides the monthly change in thousands of jobs seasonally adjusted (SA). During a worldwide debt and balance of payments crisis in the 1980s, large banks with negative capital and failure of 8 percent of commercial and savings banks and 25 percent of savings and loans banks, the US grew rapidly and created jobs in accelerated pace. There is nothing unique in the current recession in terms of policy challenges compared with the 1980s except for the lower growth in the current expansion and fewer jobs for the population in working age.

Table 1, Monthly Change in Jobs, Thousands SA

Month	1981	1982	1983	2008	2009	2010	Private
Jan	95	-327	225	-10	-779	14	56
Feb	67	-6	-78	-50	-726	39	62
Mar	104	-129	173	-33	-753	208	158
Apr	74	-281	276	-149	-528	313	218
May	10	-45	277	-231	-387	432	74
Jun	196	-243	378	-193	515	-175	61
Jul	112	-343	418	-210	-346	-54	107
Aug	-36	-158	-308	-334	-212	-54	67
Sep	-87	-181	1114	271	-225
Oct	-100	-277	271	-554	-224
Nov	-209	124	352	-728	64
Dec	-278	-14	356	-673	-109

Source: http://data.bls.gov/PDQ/servlet/SurveyOutputServlet

http://www.bls.gov/schedule/archives/empsit_nr.htm#2010

IIA Credibility Gap of Fiscal Policy. In the view of the outgoing Chair of the President’s Council of Economic Advisers (CEA), Professor Christina D. Romer of the University of California at Berkeley, the current recession has been difficult to reverse with policy measures because of its uniqueness (http://www.whitehouse.gov/administration/eop/cea/ ). According to this view, the current recession does not resemble the experience of the 1980s when interest rates were high before the recession such that lowering rates by monetary policy stimulated construction, spending and business investment. The current recession was allegedly caused by “regulatory failures and unsound practices that contributed to a housing bubble and eventually a full-fledged financial crisis” (Ibid, 2). The recession is allegedly unique and without prior parallel except for the Great Depression: “an all-out financial meltdown in the world’s financial system is something the world has experienced only once in the past century—in the 1930s. Thus, the President took office in the midst of a recession of historic proportions, but for which history provided little guidance” (Ibid, 2). In fact, the recession and recovery during the 1980s occurred during a major worldwide debt crisis that nearly wiped out the largest banks and a decade-long banking crisis in the United States, as documented in the previous section. Another feature in this view is the speed and depth of the contraction of the productive or real sector of the economy as a result of the credit crisis. GDP was initially forecast to decline by an annual SA rate of 3.8 percent in 2Q08 but the actual decline was 6.8 percent. In fact, the largest SA annual quarterly contractions in the current recession were 6.8 percent in 4Q08 and 4.9 percent in 1Q09, which are comparable with those in the 1981-1982 recession: -4.9 percent in 4Q81 and -6.4 percent in 1Q82 (see Table 1 in the prior post of this blog of Aug 29, 2010). There were simultaneous declines of GDP in major economies worldwide in the current recession. The response of the administration was the American Reinvestment and Recovery Act of 2009 (ARRA) with an effective increase of spending by $862 billion. Additional efforts consisted of the Financial Stability Plan (FSP) that ended mostly as stress tests instead of the unfeasible purchase of distressed assets held by banks (Pelaez and Pelaez, Financial Regulation after the Global Recession, 164-6, Regulation of Banks and Finance, 226-7). Banks recovered their own balance sheets and stress tests merely measured that effort. Other policies were the use of $50 billion of TARP funds to prevent foreclosure of house loans and the restructuring of two automotive producers.

The CEA finds substantial benefits from policy: GDP has been growing during four consecutive quarters and employment has been growing again in 2010 (http://www.whitehouse.gov/administration/eop/cea/ ). However, the CEA acknowledges that growth has been insufficient to increase employment as desired. The original report estimated that the effects of ARRA would increase GDP by 3.75 percent and payroll employment by 3,675,000 jobs (http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf 4) “relative to what otherwise would have occurred” (http://www.whitehouse.gov/administration/eop/cea/ 8). The CEA contends that “there is widespread agreement that the Act is broadly on track to meet these milestones” (Ibid, 8). Unemployment has stuck at around 9.5 percent, not rising more because of people being dropped out of labor force statistics, instead of the forecast 8 percent. The CEA explains this discrepancy by the sharper than expected contraction of the economy: “our estimates of the impact of the Recovery Act have proven quite accurate. But we, like virtually every other forecaster, failed to anticipate just how violent the recession would be in the absence of policy, and the degree to which the usual relationship between GDP and unemployment would break down” (Ibid, 9). The current sad state of the economy is explained by the CEA by unpredictable features of the recovery such as the continuing housing slump that causes increases in savings to replenish lost wealth, again in similarity with the Great Depression. The response has been additional “temporary recovery measures” of $266 billion in the 2011 budget. The failure of Congress to enact all that was proposed by the Administration has prevented the additional support needed for economic recovery (Ibid, 11). The diagnosis by Professor Romer is that “GDP by most estimates is still about 6 percent below trend. This shortfall in demand, rather than structural changes in the composition of our output or a mismatch between worker skills and jobs, is the fundamental cause of our continued high unemployment. Firms aren’t producing and hiring at normal levels simply because there isn’t demand for a normal level of output” (Ibid, 12). The policy prescription could include a combination of low-cost initiatives such as exporting more with implementation of regulation that front loads benefits. In the short run, the CEA finds the need for “the government to spend more and tax less” (Ibid, 13).

Professor Michael Boskin of Stanford, former Chairman of the CEA, provides different analysis in an article for the WSJ (http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html ). The critical historical perspective is that average quarterly rates of growth in the expansions after a severe recession were incomparably higher than during the current expansion: 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975, 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter in 1983 and only 3 percent in the first four quarters and 2.9 percent forecast in the first 12 quarters after the trough in the third quarter of 2009. The uncertainty plaguing the recovery is not concentrated on the economy alone but also on economic policy. The minutes of the FOMC meeting on Aug 10 provides evidence on an important cause of weakness in investment, spending and hiring: “a number of participants reported that business contacts again indicated that uncertainty about future taxes, regulations, and health-care costs made them reluctant to expand their workforces” (http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20100810.pdf 7). Even if the stimulus had been accurately measured and GDP forecast precisely, the structural shock to the economy resulting from restructurings and regulation affecting business models would have prevented fast recovery and full employment. The expectation of increases of taxes because of the upward tilt of government spending is frustrating investment, consumption and hiring.

IIB Credibility Gap of Monetary Policy. Fed Chairman Bernanke provides an explanation of the financial crisis in terms of triggers, originating the crisis, and vulnerabilities, amplifying its depth and reach to production and employment (http://www.federalreserve.gov/newsevents/testimony/bernanke20100902a.htm ). The $1 trillion of subprime mortgages is a commonly considered trigger but it is insufficient to explain the crisis and recession. Another trigger was the contraction of asset-backed commercial paper (ABCP) that finances significant part of credit. The reform-oriented approach focuses on laxity in the private financial sector and public policies. The private sector vulnerabilities analyzed by Bernanke are: (1) reliance on volatile short-term funding through securitization, money market funds, investment banks, mortgage banks and many others that financed securities with long-term maturity with short-dated funds such as sale and repurchase agreements (SRP); (2) weak risk management by financial institutions; (3) excessive leverage; and (4) derivatives with high risk and leverage without observable prices. The shortcomings of public policy were: (1) lack of regulation for the shadow bank system; (2) failure in using existing authority; (3) lack of resolution authority for large financial companies; and (3) growth of financial entities because of the “too big to fail” doctrine. A major credibility issue of monetary policy is that an alternative interpretation attributes the origins of the crisis to monetary policy. The misallocation of resources and loss of employment was primarily caused by monetary policy jointly with housing policy considered in turn (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). First, the Fed lowered interest rates to 1 percent between Jun 2003 and Jun 2004 with the objective of preventing deflation while simultaneously Treasury suspended the issue of 30-year Treasuries with the objective of increasing purchases of 30-year mortgage-backed securities to lower yields and stimulate housing. Policy is not very different currently except in much higher dimensions with the fed funds rate at 0 to 0.25 percent and directly attempting to lower mortgage rates by a Fed portfolio of $1.98 trillion of long-term securities (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1 ) instead of suspending the auctions of 30-year Treasuries. Monetary policy created problems instead of reckless management of financial institutions. Near-zero interest rates and the effort to reduce long-term interest rates created the impression that financial assets would never decline in value, encouraging high leverage, low liquidity, excessive risk and careless credit decisions, which are the vulnerabilities in this view that amplified the crisis. The wording of the Federal Open Market Committee (FMOC) “forward guidance” created the illusion of near-zero interest rates forever such that the Fed would prevent losses in financial exposures, which was similar to the Fed writing a put option, or floor, on asset values. In fact, as it happens currently, Fed policy intended to encourage risk and spending to pump the economy by creating the illusion that brakes would not be applied indefinitely. Financial institutions are now blamed with hindsight for taking the risk that Fed policy induced and intended in 2003-2004 and currently for not taking risks again with the same policies while regulation lowers credit volumes and increases interest rates. Second, the near-zero interest rates and suspension of the issue of 30-year Treasuries merely magnified the effects of a yearly subsidy of housing measured in 2006 at $221 billion, policy of affordable housing, capital by Fannie and Freddie of $900 per $200,000 mortgage (Edward J. Pinto http://professional.wsj.com/article/SB10001424052748704407804575425231311880538.html) and acquisition or guarantee by Fannie and Freddie of $1.6 trillion of nonprime mortgages (http://www.aei.org/docLib/20090116_kd4.pdf 7 cited in Pelaez and Pelaez, Financial Regulation after the Global Recession, 42-8, Regulation of Banks and Finance, 219-20). Fannie and Freddie were under lax oversight by tax-creating political institutions compared with oversight by boards and internal controls of for-profit financial institutions. The effort now is to perpetuate Fannie and Freddie which are “too politically important to fail.”

IIC Credibility Gap of Regulation. The Chair of the FDIC, Sheila Bair, finds “three pillars of financial reform needed in the wake of the crisis: resolution authority, systemic oversight and consumer protection” (http://www.fdic.gov/news/news/speeches/chairman/spsep0210.html ). The Dodd-Frank act of financial regulation consists of an extremely complex and draconian regulatory framework with unpredictable consequences for individual provisions and a black hole for the whole law after rules and other decisions left to regulators. Dismembering financial institutions will make them and the financial system more vulnerable to crisis. Resolution authority and systemic oversight will not eliminate risks of institutions failing because of failure of others but rather creates a new risk of regulatory errors in preventing a market exit by change of control instead of the devastating mess of liquidation. Concentration of banks on lending by transferring proprietary trading and other lines of business to hedge funds will make banks less diversified and riskier and the system more prone to crisis. Regulatory zeal will increase the costs and reduce the volume of bank capital, ultimately raising interest rates and reducing volume of credit to all. Credit is used by households, business and financial institutions such that an increase in its cost and reduction of its availability will restrain investment, spending and hiring, making this jobless recovery a unique prolonged event.

III Economic Indicators. Short-term economic indicators of the US economy continue to show a moderately expanding economy but not at a sufficient pace to stimulate employment. Personal consumption expenditures increased by 0.4 percent from Jun to Jul in current dollars and by 0.2 percent adjusted by inflation. Personal income in current dollars grew by 0.2 percent after being flat in Jun and disposable personal income adjusted for inflation fell 0.1 percent. The price index of personal consumption expenditures increased 0.1 percent in Jul (http://bea.gov/newsreleases/national/pi/pinewsrelease.htm ). The business barometer index of the Chicago ISM fell to 56.7 in Aug from 62.3 in Jul, suggesting strong but decelerating growth and new orders slowed from 64.6 in Jul to 55.0 in Aug (https://www.ism-chicago.org/chapters/ism-ismchicago/files/ISM-C%20August%202010.pdf ). The ISM manufacturing index increased from 55.5 in Jul to 56.3 in Aug but the index of new orders fell from 53.5 in Jul to 53.1 in Aug (http://www.ism.ws/ISMReport/MfgROB.cfm ). The nonmanufacturing index of the ISM fell from 54.3 in Jul to 51.5 in Aug and the index of new orders from 56.7 in Jul to 52.4 in Aug (http://www.ism.ws/ISMReport/NonMfgROB.cfm ). The SA rate of construction spending in Jul of $805.2 billion was 1.0 percent below the revised Jun estimate of $813.1 billion and 10.7 percent below the Jul 2009 estimate of $901.2 billion (http://www.census.gov/const/C30/release.pdf ). New orders of manufacturers rose 0.1 percent in Jul after falling 0.6 percent in Jun and 1.8 percent in May (http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf ). Business nonfarm labor productivity fell at a 1.8 percent annual SA rate in the second quarter of 2010 with hours increasing 3.5 percent and output 1.6 percent. The average annual rate of increase of productivity in 2000-2009 was 2.5 percent (http://www.bls.gov/news.release/pdf/prod2.pdf ). Initial claims for unemployment insurance increased to 472,000 in the week ending on Aug 28 or by 6000 from the revised 478,000 a week earlier. Nonseasonally adjusted claims fell by 6400 to 378,511 in the week ending Aug 28 (http://www.dol.gov/opa/media/press/eta/ui/current.htm ). The index of pending home sales of the National Association of Realtors increased 5.2 in Jul but is lower by 19.1 percent relative to Jul 2009 (http://www.realtor.org/press_room/news_releases/2010/09/pending_rise ).

IV Financial Turbulence. Major world stock indexes rose in the week ending on Sep 3, partly because of the relief that economic data are showing deceleration of the rate of growth but without any indications of the economy falling back into recession. The purchasing managers’ indexes for many countries provided by WSJ research confirm moderate growth worldwide (http://blogs.wsj.com/economics/2010/09/01/world-wide-factory-activity-by-country-8/ ). Commodities also gained in the week with oil moving toward $74/barrel. Treasury yields backed up to 2.713 percent.

Table 2, Stocks, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	% Trough	% 9/03	Week 9/03
DJIA	26-Apr	2-Jul	-13.6	-6.8	2.9
S&P 500	23-Apr	2-Jul	-16	-9.3	3.7
NYSE Financial	15-Apr	2-Jul	-20.3	-12.3	4.9
Dow Global	15-Apr	2-Jul	-18.4	-10.9	3.7
Asia Pacific	15-Apr	2-Jul	-12.5	-6.0	2.7
Shanghai	15-Apr	2-Jul	-24.7	-16.1	1.7
Europe STOXX	15-Apr	2-Jul	-15.3	-6.4	3.7
Dollar	25-Nov	25-Jun	22.3	18.5	-0.5
DJ USB Com	6-Jan	2-Jul	-14.5	-9.3	2.6
10 Year Treasury	5-Apr	27-Aug	3.986	2.713

Source: http://online.wsj.com/mdc/page/marketsdata.html

V Interest Rates. The 10-year Treasury yield backed up to 2.71 percent on Sep 3 relative to 2.65 percent in the prior week but was still lower than 2.95 percent a month earlier. The 10-year Treasury maturing in 08/2020 with coupon of 2.63 percent was priced on Aug 27 at a yield of 2.647 percent or equivalently at a price of 99.78 (http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=GOV-270810 ). The price on Sep 3 of that Treasury was 99.28 or equivalent yield of 2.71 for a capital loss of 0.5 percent in the week (http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=GOV-030910 ). The price corresponding to the yield of 3.986 at the peak of Apr 5 for settlement on Aug 7 would be 88.908 for a capital loss of 10.4 percent. The price for yield close to 3 percent one month ago would be 96.824 for a capital loss of -2.5 percent. Further purchases of Treasuries by the Fed could depress yields even more, creating a trap of capital losses as portfolio managers dump duration during a backup of yields, which was one of the vulnerabilities that amplified the financial crisis.

VI Conclusion. The Bank of Japan took exceptional measures to ease monetary policy in an effort to reverse the appreciation of the yen that is hurting exporters and overall economic activity (http://professional.wsj.com/article/SB10001424052748703618504575460662350463290.html?mod=wsjproe_hps_TopLeftWhatsNews ). Earlier exchange-rate interventions by Japan and the G3 have not been very successful (Pelaez and Pelaez, The Global Recession Risk, 107-9). Monetary authorities may not be able to manipulate currencies in an FX market that has grown to $4 trillion of daily volume (http://www.bis.org/publ/rpfx10.pdf?noframes=1 ). Monetary policy is confronting the zero bound of interest rates with a Fed portfolio of $1.98 trillion of long-term securities and the risk of creating a duration trap of capital losses in attempts to lower long-term yields further. Fiscal policy is also reaching the limits of how much more government spending can increase after creating trillion dollar deficits indefinitely. Policy must shift from restructurings of economic activity to reducing uncertainty in decisions by business and households within existing business models and structures to provide breathing room for the private sector to create employment (Go to http://cmpassocregulationblog.blogspot.com/ http://sites.google.com/site/economicregulation/carlos-m-pelaez)

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