World Prices

by Thomas Cooley, Peter Rupert, and Zach Bethune

The problem of deflation is not just a concern for fans of American Football. It has been troubling economists and financial market observers since Japan slipped into deflation in their lost decade of the 1990’s and the concern has become more pronounced as the European Economy, particularly the Eurozone, has struggled to escape from a lost decade of its own following the financial crisis of 2007-2009 and has been on the brink of deflation – a sustained fall in the price level – for the past few years. Now, with commodity prices falling and the European Economy in continued stagnation, the ECB has finally decided to undertake some serious monetary stimulus in the form of large scale purchases of sovereign debt, as has been done in most of the other major economies of the world over the past few years. Their goal is to stimulate their stagnant economy, improve their competitiveness by lowering the value of the Euro relative to the dollar, and stave off deflation. In a global economy domestic policy actions have ripple effects, sometimes large ones, on other economies. If countries were all trying to improve their competitiveness at once it can look like a currency war or at least be confusing.

The U.S. Bureau of Labor Statistics recent release showed the U.S. CPI declining at the end of 2014 raising the issue of downward price pressures in the U.S. Not all of this was a reflection of declining energy prices – they have been falling rapidly in the past year – because core inflation, excluding food and energy, has been falling as well. What is going on with world prices and how does it impact the U.S. economy? Since the economy is recovering well as we have documented in previous posts, the pressure on the Federal Reserve to normalize monetary policy and begin raising interest rates should come about largely because of concerns about inflation. But, the current environment is one in which the struggles of some our most important trading partners has incentivized them to push the value of their currencies down, lowering import prices in the U.S. but also stimulating capital inflows to the strong U.S. economy.

First, lets look at prices in a collection of important economies. The picture below shows the broad CPI or equivalent for Japan, the U.S. and some key European economies.

cpi-all-items-foreign-2015-01-21
Prices have turned down, more dramatically in some countries than others, and as the following picture shows it is not just energy prices that is driving them.
cpi-core-foreign-2015-01-21

These price levels reflect a complex set of drivers and ultimately what is going to be most important is the relative price of currencies. The countries that have been most stagnant are the Euro area nations and Japan. (An earlier post also contrasted these areas to the BRICs). The picture below shows the relative performance of these economies in the aftermath of financial crises. Real GDP growth is stagnant in Japan and the Eurozone economies as we have documented before. The U.S. and U.K. in contrast are recovering well and showing steady growth.

gdp-US-EU17-Japan-UK2015-01-21

More important than the price level, however, is the relative price of the currencies. The picture below shows the real effective exchange rates for the Euro, Yen, Pound and Dollar. What they show is that the dollar and pound have appreciated sharply and the Yen has depreciated sharply.  The Euro, adjusted for domestic inflation, has not moved much.  The Euro zone countries need the real value of their exchange rate to decline sharply with the ECB’s policy in order to restore their competitiveness.  But they are hampered in the end by the fact it is one currency that links very disparate economies.  It remains to be seen how effective they are.

real-exchange-rates-2015-01-21

The Labor Market Downturn and the Role of Consumer Credit

by Zach Bethune, Thomas Cooley and Peter Rupert

The labor market added 252,000 jobs in December according to the Employment Situation released today. In addition, there were substantial positive revisions to last two months: 243k to 261k in October and 321k to 353k in November.

empchgm-2015-01-09

The unemployment rate declined to 5.6%, which marks the lowest it has been since mid 2008. While the number of unemployed workers hasn’t fallen to its pre-recession level, the remaining ‘slack’ left in the labor market is largely due to the longer-term unemployed or those with jobs but who are underutilized, like the part-time workers for economic reasons. The story in terms of how (and in which dimensions) the labor market is recovering remains the same: slow but continued progress after a historically deep recession.

emp-rec-rec-2015-01-09

Our usual goal in these posts is to describe where the US is in its now 7-year recovery from the recent recession. However, we ask a different question in this post (one that has been the central focus of many economists since the crisis started): why was the downturn in the labor market so deep?

The Labor Market Downturn

Compared to past recessions, the increase in unemployment during the Great Recession was the worst since the Great Depression. The unemployment rate more than doubled from mid 2007 to late 2009. Even compared to recent recessions, this crisis was particularly severe. What factors led to such a severe recession? In my job market paper, “Consumer Credit, Unemployment, and Aggregate Labor Market Dynamics”,  I study the role of  households’ ability to access and use consumer credit when they become unemployed and ask if this relationship, at the household level, can help us explain the depth of the recent recession.

urate-cyc-2015-01-09

The Role of Consumer Credit

The Great Recession was unique in many respects, but a feature that continually stands out has been the response of household debt and borrowing. The credit boom of the late 1990s led many households to increase their reliance on debt to finance consumption and investment. The ratio of debt-to-income increased from around 0.6 in the 1980s to nearly 1.2 at the peak of the boom in 2007. During the crash, both debt and borrowing fell at rates never seen before as the unemployment rate doubled. Debt-to-income currently stands around 0.95.

Not only was the pattern in unemployment and borrowing similar in the aggregate, we also see them linked if we look across regions of the US. For instance, counties that had the largest increase, and subsequent fall, in borrowing during the Great Recession also tended to be the counties that experienced the largest declines in employment or increases in unemployment (see an excellent non-technical summary of this work here). These facts have led to a new emphasis on research into how problems in household financial markets might exacerbate recessions.

One area of household debt that was a strong predictor of the response of unemployment was borrowing on consumer credit lines, mostly comprised of credit cards(Mian and Sufi, 2009). The fall in consumer credit borrowing between 2007 and 2009 was nearly twice as large as in the previous 4 recessions.

cc-borrow-2015-01-09

Not only were households borrowing less, it was also more difficult to access the consumer credit market. Evidence from the Federal Reserve Board’s Senior Loan Officer’s Survey suggests that lenders were tightening credit card standards and also decreasing limits on outstanding accounts. Consumer credit became more difficult to access during the Great Recession at the same time that the labor market was deteriorating.

credit-standards2

This leads to the question of what was happening at the household level between a consumer’s access to credit and their labor market status. Evidence from the 2007-2009 Panel Survey of Consumer Finances suggests that not only was credit being tightened for all consumers over this time period, but that it was being tightened more strongly for consumers that lost their jobs. These households applied for credit more frequently and were denied at a higher rate. The difference in the rate of denials was driven by denials that were employment and income related, being told by lenders that their income was too low. In the end, the rate of monthly borrowing fell 60% more for an average consumer that lost their job than an average consumer that maintained employment. Put simply, a job loss over the Great Recession corresponded to a significant reduction in a household’s ability to borrow on consumer credit.

Accounting for this relationship in a macroeconomic model leads to recessions that are around 70% deeper than what a standard model would predict. A shock to the economy, say a fall in productivity or house prices, gets amplified if the unemployed face tighter credit constraints. As the unemployment rate increases, a higher fraction of households are credit constrained, borrowing falls, and subsequently the demand for firms’ products. The decrease in ‘aggregate demand’ lowers firms’ demand for labor which induces more unemployment. This cycle repeats itself, causing the recession to become deeper.

Conclusions

The evidence above highlights two aspects of why the fall in household borrowing between 2007 and 2009 corresponded closely with the increase in unemployment. First, the complementarities between the household credit market and the labor market run down to the household level. It became more difficult to borrow precisely for households that demanded it the most, the unemployed. Second, this relationship affected the incentives for firms to hire, which exacerbated the initial causes of the recession.  Accounting for the relationship between borrowing and unemployment at the household level is important in understanding the trends we see aggregate data.

 

Sources

Bethune, Zachary (2014), “Consumer Credit, Unemployment, and Aggregate Labor Market Dynamics” in mimeo. 

Mian, Atif and Amir Sufi (2010), “Household Leverage and the Recession of 2007 to 2009″ IMF Economic Review, Palgrave Macmillan, vol. 58(1), pages 74-117, August.

Q3 GDP Final Estimate: Christmas Came in The Third Quarter

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced in the 3rd estimate that real GDP increased at a s.a.a.r. of 5.0% for 2014 Q3. This was the strongest quarterly growth rate in over a decade.  It seems clear that the U.S. recovery is continuing apace and, if the economy is not held back by weak growth in Europe and the BRICS, we should continue to improve. A favorable sign is that personal consumption expenditures (PCE) contributed about half of the total, split pretty evenly between goods and services. Durable goods expenditures continued to be strong, increasing 9.2% after a 14.1% increase in the 2nd quarter.

 

gdprealchgm-2014-12-24


pcerealchgm-2014-12-23

How confident should we be that this expansion has legs?

Five percent growth is a healthy number and a good excuse for an extra glass of holiday cheer. It still makes sense, however, to view this recovery in the context of other business cycles. When we do, it is apparent that this economy is still climbing out of what was a very deep hole and very tepid recovery to date. The pictures below show the path of GDP, Consumption and Investment, in this recovery contrasted with the paths of other post-war business cycles. This makes it clear that, while things are looking better, we might want to keep the good champagne corked for a while longer. The fact that this recovery is set against the background of a world economy that is very feeble is a cause for tempering the optimism.
gdp-cyc-2014-12-24
pce-cyc-2014-12-24
inv-cyc-2014-12-24
gdpconinv-2014-12-25

Another positive sign for the holiday is the report from the BLS today that, once again, initial claims for unemployment has declined. The 4-week moving average has been trending down and now is as low as at any time over the last several decades.

claims4w-2014-12-24

The Context

The picture below reprises a theme from our previous post.  The U.S. recovery looks great when contrasted with Japan and Europe. The question is can we continue to sustain this progress when they are struggling? Economic linkages wax and wane as the terms of trade change between nations. Falling commodity prices have strengthened the U.S. dollar. Some trading partners have pushed down the value of their currencies. These contribute to keeping inflation low and this in turn helps domestic consumption. Most signs point to the recovery continuing to be robust but there are many moving parts to this picture and we will have to continue to watch them all.

 

gdp-US-EU17-Japan-2014-12-23

November Employment Crushes Estimates

by: Zach Bethune, Thomas Cooley, Peter Rupert

The Employment Situation released Friday by the Bureau of Labor Statistics reported that payroll employment increased 321,000 in November, beating the “best guesses” by roughly 100,000 jobs! This represents the largest gain since May, 2010. Moreover, the number of jobs have been revised up for the previous two months: 23,000 more in September and 29,000 more in October. Indeed, revisions to employment have been positive for almost all of the last year!

empchgm-2014-12-05

According to the household survey the unemployment rate was unchanged at 5.8%; however, the unemployment rate actually rose from 5.67% to 5.82% as there were only 4,000 more employed according to the household survey while the labor force expanded by 119,000. The employment to population ratio was unchanged at 59.2 and the labor force participation rate was also unchanged, remaining at 62.8. The number of persons working part time for economic reasons (PTER) fell by 177,000 and most of that decline (150,000) came from a reduction in those reporting slack work or business conditions. However, while the latest report is the strongest in some time, the transition rates we calculate from CPS microdata illustrate that these part-time workers are still having trouble finding full-time work. There are still 6.9 million PTER workers that would like to be working full-time; nearly two million more than there where pre-Great Recession. Given that the transition rates slow little signs of improvement, we expect the number of PTER workers to decline slowly.

uu6rate-2014-12-05

epr-2014-12-05

lfp-2014-12-05

parttimefrac-2014-12-05

pter-2014-12-05 rate-pter-fter-2014-12-05 rate-pter-unmp-2014-12-05

Further evidence that the labor market is strengthening is that average hours of work increased as did average hourly earnings.

avghours-2014-12-05

ahe-2014-12-06

The stronger labor force was a reflection of the stronger economy overall that we discussed in our last report.  The fall in people working part time for economic reasons is another sign that constraints are easing. The strength of the report adds strength to the argument for the Fed to begin increasing rates sooner rather than later.

Q3 GDP Gets a Lift and Invites a Global Perspective on the U.S. Economy.

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced the second estimate for real GDP this morning, boosting Q3 growth to 3.9% from 3.5% announced in the advance estimate. The increase came largely from boosts in  business investment and consumption. The equipment component of business fixed investment increased 10.7%. Residential structures showed only a 2.7% rise while the Case-Shiller and FHFA home price indices were essentially flat.

The contribution of investment to GDP growth was less than a third of the contribution in the second quarter while the contribution of Exports, while still positive, was less than a half of what it was.  The GDP numbers suggest that the U.S. economy is strong and resilient although there are reasons for concern. Chief among these concerns is that major trading partners of the U.S. are struggling – some of them mightily.  In this post we look at the U.S.in relation to other major trading partners and the powerful emerging economies. Our comparisons are somewhat hampered by the reliability and availability of data (see our rant on europeansnapshot) but we show what we can.

gdprealchgm-2014-11-25
The U.S. in Perspective

North America

The first thing to note is that North American Economy as a whole is recovering well. The U.S., Canada and Mexico are all expanding in the seven years since the financial crisis of 2007-2009 brought many of the worlds economies to their knees. The picture below shows the trajectory of the North American economies since the financial crisis.  This is important because Canada is the top U.S. trading partner and Mexico ranks third behind China. If these economies were faltering that would hold back the U.S. but they are not.

 

gdp-US-CAN-MEX-2014-11-26

 

Europe and Japan

Outside of North America the other most important trade relationship is with Europe. Taken as a whole the EU accounts for 17% of world GDP, slightly more than the U.S. Europe – U.S. trade accounts for 40% of world trade in services and 30% of world trade in goods. Japan accounts for about 5% of world GDP and is the fourth largest trading partner.  The picture below shows that Europe and Japan are both stagnant.  The European debt crisis is in the past but the crisis revealed many weaknesses in the design and execution of European integration that has resulted in what we called Europe’s Lost Decade on our companion blog. Japan has experienced two quarters of recession as Mr. Abe’s “three arrows” policy has seemingly backfired.  Although the U.S. looks strong by comparison to these major trading partners their weakness constitutes a major headwind for the U.S. economy.  If they are not well it is harder for us to do well.

gdp-US-EU-Japan-2014-11-26

 

 

GDP slowing in BRICS

Much of the momentum in the world economy for the past decade has been contributed by the fast growing emerging market economies referred to as the BRICS – Brazil, Russia, India, China and South Africa. Data limitations are a major limitation in looking at these economies but the pictures below give a sense of the recent pattern. Brazil has slipped into recession as has Russia. Partial data suggests that Chinese growth is slowing. The BRICS excluding China seem to be slowing somewhat, growing more at the pace of the U.S. than at their historical pace.

gdp-US-BRICS-2014-11-26

gdp-US-EU17-Japan-BRICS-2014-11-26

gdp-US-EU17-Japan-BRICS-no-china-2014-11-26

The Engine of World Growth? 
However disappointing we may find the pace of this recovery, The U.S. and North American economies look decidedly stronger than those of our other major trading partners. Without more widespread recovery U.S. growth will be held back. But Japan and Europe suffer from structural problems – unfavorable demographics and inefficient labor markets that are not easily fixed. It may be that we should be giving thanks for our blessings.

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