The Employment Report, and the Need for Maintaining Stimulus

by Menzie Chinn

The Employment Report in Brief

The WSJ RTE post title says it pretty clearly: Economists React: Jobs Report an ‘Unmitigated Disaster’. My two observations are:

• Overall employment is being reduced by continuous reductions in government (primarily state and local) employment. Private sector employment growth was 57,000.
  
• Hours continue to rise faster than employment in the private sector.

Figure 1: Month on month change in government employment, ex.-Census (blue) and total private industry (red), in thousands, seasonally adjusted. Source: BLS via St. Louis Fed FREDII.

Figure 2: Log private sector employment (blue) and log aggregate weekly hours (red), both normalized to 2009M06, seasonally adjusted. Source: BLS via St. Louis Fed FREDII, and author’s calculations.

More from CR. With the economy clearly in a weak patch, one has to think very carefully about how a fiscal consolidation package is crafted.

Thinking Carefully about Fiscal Consolidation

Various international organizations have weighed in on the need for fiscal consolidation in the US, while at the same time arguing against an overly hasty withdrawal of stimulus (both fiscal and monetary). For instance, in its most recent concluding statement to the Article IV mission on the US (June 20), the IMF wrote:

… Fiscal policy consolidation needs to proceed as debt dynamics are unsustainable and losing fiscal credibility would be extremely damaging. However, the pace and composition of adjustment should be attuned to the cycle, within a politically-backed strategy that raises medium-term revenues and addresses long-term expenditure pressures. …

In fact, with government spending on goods and services shrinking, stimulus is already being withdrawn.

Figure 3: Real GDP growth (blue bar), spending growth attributable to total government (red bar), and to Federal government (green bar), all in percentage points, SAAR. NBER defined recession dates shaded gray. Source: BEA, 2011Q3 3rd release, and NBER.

Macroeconomic Advisers has just released their of what a fiscal consolidation along the lines of Simpson-Bowles would imply.

Assuming current fiscal policies remain in force, our economic model suggests
that interest rates will rise considerably over the next decade, with the yield on the
10-year Treasury note reaching nearly 9% by 2021.
. . .

We estimated the effects of a fiscal contraction that is patterned after the so-called
Bowles-Simpson plan and that averts this dire scenario.

• The plan would pare more than $4 trillion from the federal debt by 2021 relative to
  current policy.
  
• Roughly two thirds of this contraction is from spending cuts, the rest from tax
  increases.

For a given path of long-dated yields, the macroeconomic effects of the fiscal
contraction are sizable.

• “Fiscal drag” would reduce real GDP growth by 0.4 to 0.5 percentage point per year
  through 2015, leaving the unemployment rate a percentage point higher by then.
  
• Core inflation would remain well below a rate consistent with the FOMC’s
  interpretation of price stability, reaching only 1.4% by 2021.

The Macroeconomic Advisers simulations do not envisage a “expansionary fiscal contraction” — no surprise given the fact that the US is not near full employment, is not a relatively open economy, and interest rates are very low. [1] That is, aggregate demand is not sufficiently spurred by declining interest rates as Federal demand for credit declines relative to baseline.

Chart 4 from Macroeconomic Advisers (2011).

The paper concludes:

We agree it is vitally important to adopt a credible and sustainable fiscal policy before financial markets impose an even harsher discipline on the process. However, our analysis suggests the wisdom of waiting a few years until the economy is on firmer ground and the federal funds rate is well off the zero bound. Then, the FOMC could ease more aggressively into a fiscal contraction, or even ahead of it. Alternatively, if we are to proceed immediately, a more measured near-term fiscal contraction, one that the FOMC could and would accommodate, seems advisable. We believe markets, which already seemed priced to a “fiscal fix,” would forgive such delays, especially if that time was used to forge significant progress on reforming entitlements, the cost of which are, after all, the primary drivers of our long-term fiscal imbalance.

The employment report reminds us that the economy is in a fragile state, and macroeconomic analysis reminds us that we cannot hope for miraculous expansionary fiscal contraction to save the day. We need to maintain short term stimulus, while cutting the future trajectory of spending.

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