The Unassuming Economist

Each release of the U.S. payroll employment report leads to a debate on the extent to which unemployment is cyclical vs. structural. I’ve just updated the estimates of U.S. structural unemployment reported in my 2011 IMF Working Paper. (Please note that IMF working papers represent the views of the authors and not the official view of the IMF or of any institution with which my co-authors are affiliated.)

The bottom line? The estimate of structural unemployment has declined over the past year in line with the decline in the actual unemployment rate. In the figure below, the solid (black) line shows the U.S. unemployment rate declining from nearly 10 percent in 2009:Q4 to about 7 ½ percent today. The dotted (red) line is the estimate of structural unemployment; it too has declined over that time and the latest estimate of structural unemployment is 6.2 percent. There is a lot of concern about U.S. long-term unemployment. In this case too, there has been a decline in the estimate of the structural component of long-term unemployment, but it is more gradual than in the case of total unemployment.

Intrigued? This post by Menzie Chinn (Econbrowser) has a nice ‘cheat sheet’ on how these estimates were constructed.

Paul Krugman has blogged extensively on how states within the US currency union have adjusted better than regions and countries within the European currency unions. My presentation at the European Regional Science Association today gives some background on this discussion and some new results.

There is further evidence that employment growth is low because output growth is poor. According to a new IMF working paper, “Much of [the cross-country differences in employment growth] are the result of the differences in real GDP growth. A scatter chart of real GDP growth and employment growth between 2008 and 2011 shows a strong correlation between the two (Figure 1). Latvia, which had the largest decline in real GDP between 2008 and 2011, also experienced one of the largest reductions in employment. And Poland, which had the largest increase in real GDP during this time period, also had one of the best employment outcomes.”  

Ball, Leigh, and Loungani also provide evidence on how well Okun’s Law has held up during the Great Recession.

Fiscal tightening, whether based on cutting spending or raising taxes, has raised inequality and lowered the wage share of income. These are the main findings of my co-authored IMF working paper released today. The results are based on 173 episodes of fiscal consolidation during 1978-2009 for 17 OECD economies (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, Portugal, Spain, Sweden, the United Kingdom, and the United States). Some of the key charts from the paper are given below.

Fiscal consolidation raises inequality (as measured by the Gini Coefficient)
(The horizontal axis shows the year of the consolidation—year 0—and the impact up to 8 years after the consolidation)

Consolidation based on spending cuts raises inequality …

… as does consolidation based on tax increases

Fiscal consolidation lowers the wage share of income

Unemployment in advanced economies averages 8% today, a sharp rise from 5 ½ % at the start of the Great Recession. European unemployment is particularly high—about 11% on average. What can be done?

In a celebrated mid-1980s paper, Olivier Blanchard, along with Rudi Dornbusch and others, argued that tackling the high unemployment and low growth in Europe at that time would require a ‘two-handed approach’: a combination of demand-side and supply-side policies. It is not coincidental that the IMF’s current advice to countries reflects the return of the two-handed approach.

In presentations delivered at the European Commission, ILO, World Bank and other venues, Prakash Loungani—advisor in the Research Department and co-chair of the IMF’s “Jobs & Growth” working group—has made the case for balancing demand and supply initiatives to tackle unemployment in advanced economies. He notes that, contrary to some assertions, unemployment and growth have remained linked during the Great Recession and the Not-So-Great Recovery. This preserves the hope that the jobs will return when the growth does.

Evidence suggests that the bulk of the rise in unemployment in most countries has been cyclical. Hence, as the Wall Street Journal noted recently, it’s time to “stop worrying about the ‘jobless recovery’ [and] start worrying about the recovery-less recovery.” Citing work on Okun’s Law by IMF authors and other recent evidence, the Journal concluded that “it isn’t unemployment benefits or other specific [structural] factors that are holding back hiring. It’s the economy, stupid.”

Several factors are behind the tepid recovery in output. In work done for the recent World Economic Outlook, Ayhan Kose, Prakash Loungani and Marco Terrones note that a key difference between the current global recovery and past global recoveries is that fiscal policy has not been able to provide the support this time that it did in the past—a point that has been picked by many observers including Paul Krugman (see the figure on fiscal spending below and Krugman’s essay here).

Real Primary Government Expenditures