Recently by Gary North: Will Bernanke Become ‘Hurricane Ben’?
Bernanke’s speech on March 26 began with a familiar analytical error. Specifically, he continued to give the impression that the Federal Open Market Committee (FOMC) is the cause of today’s low short-term interest rates. It isn’t. The .25% rate is the result of Federal Reserve policy, but not FOMC policy. The FED pays commercial banks .25% on excess reserves. If it did not pay an interest rate of .25%, the rate would be even lower. He always gives the impression that, without the FED’s intervention, rates would be higher.
The causes of today’s low rates are the widespread decisions of commercial bankers to hold excess reserves with the FED, which is what the FedFunds rate reflects. Banks are not borrowing overnight money from other banks in order to meet bank reserve requirements set by the FED. They do not need the money. They have plenty of excess reserves. So, because there is no rival demand for this money, banks put their money with the FED, which pays .25%. Better to earn something than nothing.
THE LABOR MARKET
His speech focused on the rate of unemployment, as well it should. This rate is also called the “Presidential incumbent’s chance in election years.” In the post-World War II era, an unemployment rate above 7% at the time of the election is the kiss of death.
Bernanke said this: “We have seen some positive signs on the jobs front recently, including a pickup in monthly payroll gains and a notable decline in the unemployment rate.” The unemployment rate is 8.3%. “That is good news.” For Republicans, yes. Not for Obama.
Importantly, despite the recent improvement, the job market remains far from normal; for example, the number of people working and total hours worked are still significantly below pre-crisis peaks, while the unemployment rate remains well above what most economists judge to be its long-run sustainable level.
Correct on both points. “Of particular concern is the large number of people who have been unemployed for more than six months.” Also correct. Not having anything else to do, they are likely to vote in November.
He raised the question of whether this unemployment is cyclical or permanent. He defines “cyclical” as every Keynesian does, that is, incorrectly: the result of a temporary lack of aggregate demand. “Is the current high level of long-term unemployment primarily the result of cyclical factors, such as insufficient aggregate demand. . . .?”
The cause of high unemployment is not insufficient aggregate demand in general. Rather, it is the high aggregate demand to stay home and watch TV. The problem is that some of the unemployed workers refuse to work for lower (non-labor union) wages. They do not want available jobs. Other unemployed workers are no longer worth the minimum wage. They cannot find jobs. All of them are getting paid not to work by the federal government’s unemployed workers’ bailout program, called unemployment insurance, which the government keeps extending.
He also mentioned “a worsening mismatch between workers’ skills and employers’ requirements.” He did not mention the key phrase, which every economist should always use when discussing gluts: “at the prevailing market price.” Had he done so, his audience would have expected him to discuss prevailing market wages in specific labor markets. He did not want to do this. To do so would point to the causes of unemployment: government interference with wages.
If cyclical factors predominate, then policies that support a broader economic recovery should be effective in addressing long-term unemployment as well; if the causes are structural, then other policy tools will be needed. I will argue today that, while both cyclical and structural forces have doubtless contributed to the increase in long-term unemployment, the continued weakness in aggregate demand is likely the predominant factor. Consequently, the Federal Reserve’s accommodative monetary policies, by providing support for demand and for the recovery, should help, over time, to reduce long-term unemployment as well.
Bernanke was justifying the FED’s inflationary policies, which bankroll the Federal government, which in turn spends the newly counterfeited money to “increase aggregate demand.” This has been the Keynesian solution ever since 1936. It will be the Keynesian solution forever. The Keynesian sees unemployment in terms of insufficient aggregate demand, which means insufficiently large federal deficits and insufficiently inflationary central bank policies.
Jobs are increasing in the private sector, he said. Layoffs are moderating in the public sector. But currently, hours worked are 4% less than in 2007. The job market remains weak, he said. Private sector employment is down by 5 million jobs. But the population has increased. The unemployment rate was 3 percentage points above its average over the past 20 years. Let me put it another way. The difference between 8.3% and 5.3% is 3 percentage points. What percent of 5.3% is 3%? It is about 57%. That means that the present unemployment rate is 57% above what has been normal for 20 years. Put this way, the present unemployment rate in 2012, over three years after the recession began, is a disaster.
“Moreover, a significant portion of the improvement in the labor market has reflected a decline in layoffs rather than an increase in hiring.” In short, the job-creation process is not recovering. “Taking the difference between gross hires and separations, the net monthly change in payrolls during this period was, on average, less than 100,000 jobs per month – a small figure compared to the gross flows.”
We need more hiring, he said. Quite true. How will this come about? With more rapid economic growth. Terrific. How will this growth take place?
He then went into a spasm of Keynesian babble: a discussion of Okun’s law, a 50-year old observation about unemployment and economic growth, for which there was little evidence then, and which is now long defunct. You are not expected to follow what he said next. He went professorial on his audience. This is what passes for meaningful communications in a graduate school classroom at Princeton.
About 50 years ago, the economist and presidential adviser Arthur Okun identified a rule of thumb that has come to be known as Okun’s law. That rule of thumb describes the observed relationship between changes in the unemployment rate and the growth rate of real gross domestic product (GDP). Okun noted that, because of ongoing increases in the size of the labor force and in the level of productivity, real GDP growth close to the rate of growth of its potential is normally required just to hold the unemployment rate steady. To reduce the unemployment rate, therefore, the economy must grow at a pace above its potential. More specifically, according to currently accepted versions of Okun’s law, to achieve a 1 percentage point decline in the unemployment rate in the course of a year, real GDP must grow approximately 2 percentage points faster than the rate of growth of potential GDP over that period. So, for illustration, if the potential rate of GDP growth is 2 percent, Okun’s law says that GDP must grow at about a 4 percent rate for one year to achieve a 1 percentage point reduction in the rate of unemployment.
In light of this historical regularity, the combination of relatively modest GDP growth with the more substantial improvement in the labor market over the past year is something of a puzzle. Resolving this puzzle could give us important insight into how the economy is likely to evolve. To illustrate the tension, consider the relationship between the recent changes in the unemployment rate and in real GDP relative to the predictions of Okun’s law. As illustrated by the position of the square labeled “2011” relative to the Okun’s law relationship, represented by the line, the decline in the unemployment rate over the course of 2011 was greater than would seem consistent with GDP growth over that period. Indeed, with last year’s real GDP growth below 2 percent, less than what most economists would estimate to be the U.S. economy’s potential rate of growth, one might have expected little change in the unemployment rate last year or even a slight increase. What is this confluence of the significant decline in the unemployment rate and the modest recent increase in real GDP telling us about the state of the economy, and how will the Okun’s law puzzle be resolved?
It is typical of Bernanke that he really expects his verbal constipation to persuade an audience of anything other than this: “This guy is utterly incoherent.” Greenspan was deliberately incoherent. In contrast, Bernanke is unaware of his own incoherence.
Paul Volcker spoke in English. He still does. We have had only one person like him since William McChesney Martin retired in 1970.
“In light of this historical regularity” – which isn’t – “the combination of relatively modest GDP growth with the more substantial improvement in the labor market over the past year is something of a puzzle. Resolving this puzzle could give us important insight into how the economy is likely to evolve.”
The puzzle is that he should believe that Okun’s law is a law.
If Okun’s law were a law, there would be some logical explanation for it. There isn’t. There would be detailed studies of the regularity of this law over the last half century, not just in the United States but in other nations. There aren’t. Okun’s law is not a law. It was a one-time statistical indicator.
Bernanke never, ever speaks of the unwillingness of unemployed workers to seek minimum wage jobs, or move to regions where there are jobs. That would indicate personal responsibility for unemployment, case by case, rather than insufficient aggregate demand.
A pessimistic view is that a large share of the unemployment we are seeing, particularly the longer-term unemployment, is structural in nature, reflecting factors such as inadequate skills or mismatches between the types of skills that workers have and the skills that employers demand. If this view is correct, then high levels of long-term unemployment could persist for quite a while, even after the economy has more fully recovered.
“Structural unemployment” is a code phrase in Keynesian circles for “unwillingness to take a lower wage.”
He blamed at least some of this unemployment on structural unemployment over the past two decades. “And it appears true that over the past two decades or so, structural factors have been responsible for some increase in long-term unemployment.” In short, he blamed the free market for long-term unemployment, meaning equilibrium with unemployment.
Hey, Ben: you Keynesians have been running the economic policy-making show ever since 1940. How come you haven’t got the structural unemployment problem licked yet? Keynes offered his general theory to show governments how to solve it. What seems to be the problem?
Then he said that it’s probably not structural unemployment. “However, although structural shifts are no doubt important in the longer term, my reading of the research is that, at most, a modest portion of the recent sharp increase in long-term unemployment is due to persistent structural factors.” He blamed cyclical factors. He offered some statistical examples. He offered a curve, called the Beveridge curve. Supposedly, this curve proves that the unemployment is more cyclical than structural.
Hey, Ben. It’s 2012. You have increased the monetary base by a factor of three since late 2008. The government has been running deficits of $1.3 trillion a year. What does it take for your Keynesian policies to get this cyclical labor market into the normal range?
SUMMARIZING THE SURVEY
Then he summarized his speech. The summary added nothing new. The speech said nothing new. It offered no grand theory of what is causing the unemployment. It suggested no new policy that might turn this supposedly cyclical recessionary job market into a recovery.
Notably, an examination of recent deviations from Okun’s law suggests that the recent decline in the unemployment rate may reflect, at least in part, a reversal of the unusually large layoffs that occurred during late 2008 and over 2009. To the extent that this reversal has been completed, further significant improvements in the unemployment rate will likely require a more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies.
Hey, Ben. How do we get this “more-rapid expansion of production and demand from consumers”? If you have been unable to get it since 2008, why should anyone believe that you will get it in 2012, an election year?
I also discussed long-term unemployment today, arguing that cyclical rather than structural factors are likely the primary source of its substantial increase during the recession. If this assessment is correct, then accommodative policies to support the economic recovery will help address this problem as well.
He has been accommodating this job market for over three years. The rate of unemployment is still 57% higher than the long-term average, he admits.
What will the FED do next? What it always does: monitor the situation. “We must watch long-term unemployment especially carefully, however.” The FED will produce the Goldilocks condition: just right.
Even if the primary cause of high long-term unemployment is insufficient aggregate demand, if progress in reducing unemployment is too slow, the long-term unemployed will see their skills and labor force attachment atrophy further, possibly converting a cyclical problem into a structural one. If this hypothesis is wrong and structural factors are in fact explaining much of the increase in long-term unemployment, then the scope for countercyclical policies to address this problem will be more limited. Even if that proves to be the case, however, we should not conclude that nothing can be done. If structural factors are the predominant explanation for the increase in long-term unemployment, it will become even more important to take the steps needed to ensure that workers are able to obtain the skills needed to meet the demands of our rapidly changing economy.
Steps? What steps? What has the FOMC got up its collective sleeve?
In short, even though the policies have failed to bring recovery, we are supposed to rest assured that the same policies will work someday, assuming that today’s mostly cyclical unemployment becomes mostly structural unemployment.
Question: If FED policies and Keynesian deficits have not yet converted cyclical unemployment into cyclical recovery, why should anyone believe that more of the same – unprecedented peacetime expansion of the monetary base and unprecedented federal deficits – will overcome structural unemployment?
Bernanke’s Keynesian analytical framework blinds him to the cause of the missing jobs, namely, the unwillingness of unemployed workers to take jobs at prevailing wages. The government’s policy of paying them not to work is the contributing cause. It is subsidizing workers’ refusal to cut their wage demands.
The rate of unemployment is structural because the problem is structural: (1) the FED’s prior monetary policies; (2) the minimum wage law; (3) the government’s extension of unemployment insurance; (4) the unwillingness of workers to move to where the jobs are; (5) their refusal to work at wages offered.
The FED’s policy-makers are ready to expand the monetary base in order to subsidize the federal debt, which Keynesians think will create aggregate demand. But the FOMC is not ready to do this yet.
March 29, 2012
Copyright © 2012 Gary North