The Worst Unemployment Losses Are Yet to Come

What happens next? I'm not sure. My version of the real business cycle model (some of my academic papers on it are here and here. I began applying it to this recession about a year ago, such as here and here). It does not give a definite answer, but it does drastically narrow the possibilities.

My model has no adverse productivity shocks, no shocks to capital markets (these variables just react to events in the labor market), no monetary policy, and no fiscal stimulus. Simply put: I view this as a one (type of) shock recession, and the labor market is ground zero for that shock.

One version of the model has a labor market distortion that gets progressively worse for two years, at which point it remains at that higher distortion forever. Specifically, the average marginal tax rate ultimately increases about 10-15 percentage points (more accurately, the after tax share is cut by 22 percent), but it takes 2 years for the full marginal tax rate hike to occur.

The model and data are shown below. Note that latest 12 months (4 quarters) of the data were not available when I first began writing about this model.

Click to enlarge:





[APL is real GDP per hour worked -- labor productivity -- which in the model is in fixed proportions to the marginal product of labor]

The good news from this first scenario is that the labor market will stop getting worse in 2010 (ie, employment and hours will stop falling further below trend). The bad news is that aggregate hours will never return to that previous trend, even part way. Consumption will ultimately be further below trend than it is now.

I am still working on it, but I think there's another version of the model that would fit the same data: The labor market gets even worse for a couple of more years, but eventually will be closer to the previous trend than we are now. The bad news from this second scenario is that the labor market will not stop getting worse until beyond 2010. The good news is that consumption and aggregate hours will eventually return to their previous trends, at least most of the way.

Either way, the inference I am making from consumption behavior -- it has fallen a lot by historical standards, but far less than labor has fallen -- is that the present value of lost labor is great, but much of that loss labor has not yet occurred. Whether the remaining lost labor is spread over the infinite future (the first scenario above), or concentrated in the next couple of years (the second scenario above), I do not know.

Comments

[bbro:]

The ratio of non farm payroll employment to jobless claims bottomed out in March 2009. The ratio crossed its 12 month moving average in
August 2009....moving up. The 12 month moving average of the ratio is going to turn up in 2 months. We always have positive job growth
when this turns up.....so.........Unless you project a big jump in Jobless
claims I think you could be wrong. I guess since you use words like
never I can use words like always.

Nov 15 06:45 AM

[Andrew Butter:]

Interesting, but what's the answer?

Like what will U3 unemployment be at the turn?

Nov 15 08:30 AM

[Gary A:]

Couple this with the FHA decision to tighten standards for mortgages and the dollar may rebound. We will be like Japan and our consumers will only buy on sale or not buy at all!

Nov 15 12:08 PM

[Highonlife:]

Considering it is already at 10.2, not going to stop going down for a couple of months......
and added that the BLS has admitted that something like 0.6-0.7% were not accounted for (up til march of this year, not counting further accounting issues for the following months) and that these will be added early next year, ..
this means that unemployment is already beyond the or nearing the 11% mark.
so bbro, your theory kinda fails at this juncture

Nov 15 02:30 PM

[bbro:]

Payroll gains they are a coming....SOOON....

Nov 15 04:13 PM

[Adoptsalot:]

Actually the BLS accounting errors will not be corrected until March of next year. They currently est.the unemployed at 18.5%. or 1 in 6 workers.

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On Nov 15 02:30 PM Highonlife wrote:

> Considering it is already at 10.2, not going to stop going down for
> a couple of months......
> and added that the BLS has admitted that something like 0.6-0.7%
> were not accounted for (up til march of this year, not counting further
> accounting issues for the following months) and that these will be
> added early next year, ..
> this means that unemployment is already beyond the or nearing the
> 11% mark.
> so bbro, your theory kinda fails at this juncture

Nov 15 07:09 PM

[Highonlife:]

While the BLS numbers wont be fixed, that doesnt mean the people arent unemployed currently.

Nov 16 03:05 AM

[The Recusant:]

When industries cannot hire or rehire employees, there is only one course of action to alleviate the situation. The government will have to employ them. Just like the WPA, CCC, and U.S. military during the Depression, the administration in power (both parties which know only how to tax for welfare or borrow for warfare) will have no alternative but use more government spending to either start up programs to hire low skilled or underemployed workers or start or expand a war to boost enlistment numbers. In either case, this will drive the dollar down even more as new money, created from taxes or debt, enters the economy as salaries. They will be hoping, no doubt, that the same effect will occur as after WWII with the salaries creating more demand and encouraging companies to expand.

The unfortunate outcome of this is that there is increasing reliance on government jobs as the source of employment instead of private enterprise. The dollar will lose even more value than it has since foreign banks, having already lost confidence in the dollar, will not buy Treasury notes to support a declining dollar. Likely a severe inflation will result. That's one take on the next five to ten years, anyway.

Nov 16 05:39 PM