Real Shocks Vs. Nominal Shocks

by: Scott Sumner

This is part one of two posts on business cycles. Both posts will examine one of the greatest mysteries on all of economics: Why no mini-recessions?

I’ll get into mini-recessions in the next post, but first I’d like to examine another issue; why are US recessions always accompanied by nominal shocks? And I’ll consider that issue by first examining recent events in Japan. Here is the unemployment rate since July 2010:

A few issues:

1. The graph is slightly off, the last two months are September/October, not October/November as it might appear.

2. The figures from March to August do not include the regions devastated by the quake of March 2011.

Nevertheless, for two reasons I believe the evidence strongly suggests the quake did not significantly impact Japan’s unemployment rate. First, because when the devastated regions were added to the total in September, the national unemployment rate actually fell from 4.3% to 4.1%.

And second, it was widely believed that the quake would cause lots of unemployment in Japan’s industrial heartland (Osaka to Tokyo), as supply lines were disrupted. But it clearly did not.

Keep in mind this was a mindbogglingly large real shock. The death toll was more than 10 times larger than Hurricane Katrina, and Japan is a much smaller country than the US. The devastation was enormous. Even today most nuclear plants are shutdown throughout Japan (only 11 of 60 are operating?), and electric power is rationed in some places. If this real shock didn’t affect the unemployment rate, what kind of real shock would? Industrial production did drop sharply, but quickly recovered. I’m not arguing that real shocks don’t affect output, I’m arguing they don’t affect jobs (very much.)

Some might argue that Japan is different, that Japanese firms don’t lay off workers. OK, but let’s see what happens when Japan is hit by a demand shock:

It sure looks like Japanese firms do lay off workers, at least when demand falls. The unemployment rate rose from 3.8% in October 2008 to 5.6% in July 2009. That’s a big jump by Japanese standards.

And I’d argue the same for the US. Almost all of the big jumps in unemployment in US history are due to demand shocks. I only know of one clear exception in the post-war period: 1959, when a steel strike caused the unemployment rate to rise by 0.8%, and then fall sharply. And guess what, 1959 also happens to be the only mini-recession in modern American history (that I could find.) One real shock and one mini-recession. Coincidence? I don’t think so, but I’ll examine the mini-recession issue in the next post.

PS. In fairness, there is one ambiguous case in the US; 1974. NGDP growth did slow significantly during 1974 (compared to 1973.) But NGDP growth was still fairly high, so it might be a stretch to call 1974 a nominal shock. In my view the gradual removal of price controls during 1974 distorts the data, and the negative nominal shock in the latter part of 1974 was much bigger than it looks from reported NGDP data. Others may disagree. Thus 1974 remains a possible example of a real shock boosting unemployment sharply.

PPS. The huge (20%) wage shock of July 1933 sharply reduced industrial output. But it didn’t seem to affect employment, as it was implemented along with a rule that reduced the workweek from 48 hours to 40 hours, leaving weekly wages unchanged.