U.S. Economic Snapshot

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced that real GDP increased at a saar of 2.6% for 2013 Q4 (advance estimate was 3.2% and the second estimate was 2.4%). The overall picture for the U.S. economy remains largely the same. The increase from the last estimate comes largely from personal consumption expenditures (PCE) and nonresidential fixed investment. Moreover, the increase in PCE was the largest increase since the end of 2010. The deceleration  comes mainly from a decline in inventories, a bigger decrease in government spending and residential fixed investment.

Initial claims for unemployment fell to 311k, its lowest level since last Thanksgiving and the 4-week moving average hit 318k.

by: Zach Bethune, Thomas Cooley, Peter Rupert

The February employment report from the BLS provides little material to sway anyone’s prior beliefs, although the headline jobs number was slightly higher than many prognosticators prognosticated. The establishment survey reports total nonfarm employment increased 175,000 with 162,000 attributed to the private sector and the remaining 13,000 to an increase in government workers.

Total employment has nearly reached its December 2007 level…some six years after the beginning of the recession.

The service sector added 140,000 jobs, with professional and business services adding 79,000 jobs, 24,400 of which are temporary services. Average weekly hours fell slightly to 34.2 from 34.3…and a year ago in February average hours were 34.5.

The household survey shows the number of employed (145,266,000) and unemployed (10,459,000) persons both increasing slightly. The unemployment rate ticked up slightly from 6.6% to 6.7%. Since February 2013, the unemployment rate has declined 1.0 percentage point. The employment to population ratio and the labor force participation rate were unchanged. Fortunately or unfortunately the headline story of the US remains much the same as it has been since the beginning of the recovery in mid-2009.

 

 

by Zach Bethune, Thomas Cooley, Espen Henriksen, and Peter Rupert

Is Europe about to repeat Japan’s lost decade? Six years after the Great Recession began, the Euro area has shown little sign of sustained growth.  Japan’s so called lost decade began in 1991 after several decades of rapid economic progress and sustained increases in asset prices that were suddenly reversed.  The average growth rate of real GDP per-capita declined from about 3.5% per year in the 1980s to about 0.5% per year in the 1990s and was accompanied by  rapidly decreasing equity and real-estate valuations.  But, when we compare the performance of Japan’s economy with the European economy since the beginning of the Great Recession it is clear that Europe is in far worse shape than Japan ever was.

The following Snapshot-style comparative charts show the paths of key economic variables in Japan after the peak of its equity and real-estate valuations and contrasts these with the paths of these variables in the U.S. and Europe in the years since the onset of the Great Recession. For Europe and the U.S. we set time “0” at the peak before the Great Recession.  Judging from this and the charts that follow, halfway into the decade following the onset of the Great Recession, the performance of the U.S. and, in particular, the European economy are substantially weaker than Japan’s economy was halfway through its lost decade.

Japan’s growth rate slowed dramatically at the beginning of their lost decade – GDP rose only 10% in the first six years and then flat-lined more or less completely.  Europe, by contrast fell by six percent in the first six quarters and then flat-lined at a level three percent below their peak.  The U.S. stands in contrast to both of these stories – after falling by nearly four percent in the first six quarters U.S. growth has been steady at a rate slightly less than before the collapse.

Consumption paints an even more dire picture for Europe. During the lost decade in Japan consumption expenditures never really slowed down. In the Great Recession, U.S. consumption fell initially for about 6 quarters and  has been rising ever since. Europe on the other hand started out similar to the U.S. for the first 6 quarters but then consumption growth stalled and has not improved since. It has not returned to its 2008 peak.

The labor market picture for Europe is even more discouraging and strongly reinforces the message of a lost decade.  The unemployment rate in individual countries like Spain and Italy has been widely noted. But, here we focus on aggregate employment and the data are for the EU-28 which includes some countries, like Germany, where the labor market has not really declined. Japan, Europe and the U.S. showed remarkably similar paths of employment up until the inflection point following which there was a sharp contraction in both the U.S. and Europe. In Japan, employment like output, simply stagnated.  In terms of a recovery, the U.S. labor market, after a sharp decline, is showing slow growth while Europe looks to be stuck at a permanently lower level.

While the declines in employment were steep in both the US and Europe, the path of labor productivity has been very different. In the US the recession had a negligible effect on labor productivity, which has only recently started to show signs of slowing down (see here for instance). Europe on the other hand experienced a sharp drop in productivity at the beginning of 2008, when it fell by nearly five percentage points. Data until 2010 suggest that European productivity hasn’t shown any signs of ‘catching up’ to its previous growth trend. Measuring labor productivity is particularly difficult for Europe because one needs a measure of total hours worked. Ohanian and Raffo (2011) do the heavy lifting by constructing this series for many European countries, although it is only available until 2010.

Why the Lost Decade?

Economists have offered a range of different explanations for Japan’s lost decade: (i) the government failed to deal with undercapitalized banks that were allowed to carry “zombie” loans on their books and did not have the capacity to finance new investment, (ii) a sharp drop in productivity caused desired investment to be low, (iii) frictions caused by labor law amendments in the late 1980s resulted in declining work weeks, (iv) the monetary policy response was too timid (something Abenomics is finally trying to remedy), and (v) Japan’s prospects for recovering were seriously hampered by persistent deflation.  While it is not clear that there is one compelling account, all of these elements undoubtedly played some role and all of them loom large in the current European experience.

As in Japan, European banks are most likely under-capitalized and carrying loads of overvalued (“Zombie”?) sovereign debt on their balance sheets as well as other assets of dubious quality. The European Central Bank has only gingerly approached the problem of looking at asset quality in European banks, promising to deliver results later this year. But then what? There is no plan for dealing with under-capitalized banks. In contrast to Japan and the U.S., there is no common bank regulation or resolution mechanism and there has been only tentative progress toward creating it.

As the picture below shows, investment / capital formation stagnated in Japan, both consistent with the slower growth in total factor productivity and insolvent banks that deterred lending.  The picture also shows that investment in both the United States and Europe fell relatively more at the onset of the Great Recession than investment in Japan did at the onset of the “lost decade”. In contrast to both Japan and Europe, U.S. capital formation has rebounded after an initial collapse.  Again, the European situation looks more alarming than the situation in the United States and Japan.

Whatever the reasons may have been for Japan’s ‘lost decade’, one thing is certain: more than halfway into the decade following the start of the global recession in 2008, the European economy is far worse and deteriorating. Even though economic growth in Japan stagnated in 1991, the economy continued to grow.  In contrast, the economy in Europe has contracted and is, according to all measures of economic activity surveyed in this post, at a lower level than they were five years ago.  Unless economic growth in Europe rebounds within the next couple of years, Europe is headed for a substantially worse decade than Japan’s. Surprisingly, there has been recent optimism about a European recovery, but the data do not seem to support it except for possibly Germany and the U.K.

Just as there were no quick fixes for Japan during its “lost decade”, most likely there are no quick fixes for Europe’s economy. The challenges lie in fostering economic institutions that create individual incentives and market structures that both discourage rent seeking and encourage and allow people to use their efforts to develop and produce goods and services other people value. On this score Europe has failed. They have not reformed institutions sufficiently to make their markets globally competitive and adaptable. Until they do, Europe will continue to face the possibility of an entire decade of lost income, consumption, and jobs.

by: Zach Bethune, Thomas Cooley, Peter Rupert

Following an unexpectedly weak report in December (now revised up only slightly from 74,000 to 75,000) the monthly employment report from the BLS today reveals another tepid increase of only 113,000 jobs in January.  The unemployment rate declined slightly from 6.7% to 6.6%, inching towards the Federal Reserve’s stated target of 6.5% in which they will consider changes in the federal funds rate. Since January 2013, the unemployment rate has declined 1.3 percentage points.  In all, the headline story of the US labor market remains much the same as it has been since the beginning of the recovery in mid-2009:

1.  slow, but positive job growth,

 2. a steadily declining unemployment rate.

You might think that even though the ‘recovery’ has taken longer than usual, the labor market seems to be finally reaching a healthy state. That story is consistent with the figures above. Both employment and unemployment are reaching pre-recession levels. However, there are many features of a healthy labor market that these two headline statistics cannot capture. For instance if the rate of job growth cannot keep up with population change or if  an unemployed worker becomes discouraged and leaves the labor market. Here are a few additional headlines of the current recovery:

3. A declining  labor force participation rate, currently at its 1980 level.

4. A persistently low (and unchanging) percentage of the population employed. 

5. A consistently less efficient labor market

6. Historically high unemployment duration

Private employment was up 142,000 while the government sector shed another 29,000 jobs. Very little else stands out: average weekly hours remained the same at 34.4; average hourly earnings inched up to $24.21.

From the household survey the participation rate inched up to 63.0% from 62.8%, as did the employment to population ratio, 58.8 from 58.6.

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced that real GDP increased at a saar of 3.2% for 2013 Q4. The report did little to change anyone’s mind about about the current state of the economy. The recovery continues but at a very moderate pace. Overall, it appears a solid report…although there are always things to quibble about. For the year, GDP increased at an anemic 1.9% pace, following 1.8% in 2011 and 2.8% in 2012. This can be seen in graph below which plots GDP for 10 years after the beginning of the last 5 business cycles. It is clear that the rate of growth of GDP is currently lower than in any of the previous 4 recoveries. Additionally, you can see that the average length between recessions is around 9 years (or 36 quarters). That means that the economy typically expands for 9 years before another contraction. Currently, the US is 6.25 years into its ‘recovery’ from the 2007 recession and is not close to the rate of growth in previous expansions.

Consumption growth picked up, 3.3% in the fourth quarter (the highest gain since 2010 Q4), contributing the lion’s share to overall GDP growth at 2.26 percentage points. Private domestic investment grew at a 3.4% clip, a large decline from its third quarter growth of 17.2% which can be contributed to a slowdown in both residential and non-residential structures. Government consumption expenditures and gross investment declined 4.9%. The government shutdown played a role there.

Private investment has finally risen above its pre-recessionary level in 2007 Q4. Although the housing sector has shown signs of recovery over the past year, residential investment is still far below the peak in 2007 Q4 and it declined again in the fourth quarter.

Thia is an economy that continues to recover but is hampered in part by the lack of vitality elsewhere in the world economy.  We will focus on Europe in our next post.

Anemic job growth, declining labor force participation and declining average weekly hours of work all point to a labor market the continues to struggle for good omens. The comment from the BLS Employment Situation for December is that total nonfarm payroll employment “edged” up +74,000. Evidently the synonym for edge is “barely increased at all and was much lower than anticipated.”  See the first estimate in the Net Employment Change chart. The Establishment data shows employment for November was revised up from 203,000 to 241,000, while the final estimate for October employment remained at 200,000. Wrapping up 2013, job growth averaged 182,000 per month, almost exactly the same as in 2012 (183,000 per month).

Private employment was up +87,000 while Government jobs declined by -13,000. The largest gains overall came in Private Service Producing, +90,000; with Retail (+55,300) and Wholesale (+15,400) Trade leading the way. Construction employment fell -16,000.

The Household Survey indicates that the combination of a decline in the labor force -347,000 (also a decline in the labor force participation rate to 62.8 from 63.0), and a decrease in the number of people unemployed, -490,000, gave rise to a decline in the unemployment rate to 6.7% from 7.0%. The unemployment rate one year ago was 7.9%. So, while this bellwether statistic has shown marked improvement over the past twelve months, the labor market still seems troubled. Initial claims have bounced.  Of course, the extremely cold weather throughout much of the country has certainly affected many of the variables in question over the past month.

The average length of the workweek declined slightly and average earnings increased by 1.8% – less than in recent months.

GDP Report

The third (and final) estimate of real GDP for the third quarter from the BEA reveals another large upward revision, from 2.8% in the advance estimate to 3.6% in the second, and now to 4.1% annualized growth. As mentioned in an earlier post, much of this increase came from the big pop in inventory investment (contributing 1.67 percentage points to the 4.1% increase)–likely meaning it will be unwound over the coming quarters.

The drop in government spending over the last several years is also of note. As mentioned by the Action Economics team: “We now have a 6.4% cumulative drop in real government spending since Q2 of 2010, versus a smaller 3.8% drop after the Vietnam War but a larger 11.8% drop after the Korean War.”

There was also a large revision in the new intellectual property category, from 1.7% to 5.8%; however, the category is still too new to make any comments about expected revisions.

One negative that stands out for the overall health of the economy is the rise in both initial and continuing claims. Claims are averaging 374k in December, higher than September and October. As always, there may be many “explanations” delivered ex-post….such as “the holiday season”, “computer glitches in California”, “storms”, etc. Be that as it may….initial claims have moved up over the past couple of months.

Of course the big news of the week was the Fed’s announcement of the taper. Bond purchases will be cut back by $10 billion per month. The reaction in the economy was somewhat tepid.

The last several days have given us a  a second estimate of GDP for Q3, new data on personal income, the employment report for November, and new unemployment claims. The overall picture from them is one of a steadily improving economy, although personal income fell slightly, down 0.1%.

GDP Report

The big news with the release of the second estimate of real GDP for the third quarter from the BEA was the large increase, from 2.8% to 3.6% annualized growth. However, much (most) of this increase came from the big pop in inventory investment–likely meaning it will be unwound over the coming quarters. The implication being that this alone should have little effect on forecasts of real GDP although there is an upside–inventory growth may also reflect positive expectations about future demand. Last year in Q3 inventory investment was also a large contributor (0.6 percentage points) to the overall 2.8% GDP growth. Following that, GDP growth in Q4 of 2012 was only 0.1; moreover there was a very large decline in inventories in Q4 of 2012. Still, even without the current inventory contribution to GDP growth (1.68 p.p.), GDP grew about 1.9%; perhaps not something to write home about, but certainly showing continued solid growth. Real personal consumption expenditures continue to climb steadily and investment has finally reached its level of Q4 2007. Government consumption and gross investment appears to have broken from a three year decline and has held steady for the last couple of quarters, although below the level at the beginning of the recession.

Employment Report

The Employment Situation report from the BLS added more support to the overall picture, that is, one of solid growth. There have been four fairly strong months of employment growth, with nonfarm payroll employment increasing 203,000 for November, 200,000 for October, 175,000 for September, and 238,000 for August. Moreover there are positive signs in the goods sector, with goods employment up 44,000, and over half of that in the manufacturing sector. Unemployment initial claims continue to decline–noting of course the recent effects of the government shutdown. The employment rate declined to 7% putting it in the range that Fed Chairman Bernanke cited earlier in the year as a sign that the labor market was recovering. The positive angle on this estimate is that labor force participation increased as did the employment/population ratio.  The increase was not enough to overcome the sharp drop in October.

What next for the Fed?

The recent performance of several sectors in the US leaves a big question mark for the upcoming December meeting of the FOMC. Are these recent positive signs enough to begin to taper? Has forward guidance given us enough guidance to determine the timing? Magnitude? The problem is that there are always some confounding events…Christmas is just around the corner and the Chairman is on his way out. The graceful exit strategy would be to end QE and leave Chairman Yellen with a clean slate of expectations.

This week brought a wealth of new readings on the economy with the nearly simultaneous release of the first estimates of GDP for the third quarter from the BEA and the October Employment Situation report from the BLS.  Both showed an economy that is steadily improving in spite of significant obstacles created by the global economic environment and by the political environment in Washington.  We begin this post with a summary of the the labor market data, followed by the estimates of third quarter GDP.  We finish with an updated estimate of the costs of this recession to date. The size of the loss is the most sobering information in this post.

The Labor Market

As we reported last month, the Great Recession continues to cast a long shadow over the U.S. labor market. Moreover, the government shutdown has made it difficult to interpret some of the numbers. Employment increased 204,000 (evidently much higher than expected) and private sector employment was up 212,000. While employment provided an upward surprise, both the employment/population ratio and labor force participation rate fell. As we noted in an earlier blog, the weakness in the labor market continues to play against the Federal Reserve’s earlier attempts to provide forward guidance about asset purchases and interest rates based on thresholds for the unemployment rate. As the figure below shows there were upward revisions to the two prior employment reports. Two hundred and thirty eight thousand jobs were added in August and one hundred and sixty three thousand in September.

Employment continues to crawl slowly toward the level it attained in December of 2007.

The unemployment rate in October ticked up slightly from 7.2% to 7.3%. Initial claims, obviously affected by the recent shutdown spiked up, but the trend down is also indicative of an consistently improving labor market.

Interestingly, labor productivity measured by total output divided by the total number of labor hours looks very similar to all previous recoveries except for the 2001 cycle. Even as employment fell 5% below its peak level, productivity continued to rise.

At some point in the past year the Fed indicated a threshold target for the unemployment rate of 6.5%. They had previously specified a target of 2% for inflation. If these targets were hit exactly, the Taylor Rule would imply a Federal Funds Rate of 4%. Currently, the Taylor Rule with these thresholds indicates that the federal funds rate should be significantly higher than its current level. The rule prescribes an interest rate policy of around 2%, well above the zero bound where the fed funds rate has been since 2010.

Because these implications have made bond markets jumpy – they view interest rate increases as imminent – the Fed has begun to try to walk this back a bit. A research paper released this week suggests that a thresholds should be set so that Rules don’t imply an early departure from the fully accommodating levels of the funds rate.

The employment/population ratio continues to be historically low compared to all other recoveries. It fell nearly twice as much and has shown very little recovery, as mentioned above, it fell again in October to 58.3%.

Indeed, the ratio is now about what is was back in the early 1980’s. Some of this has to do with demographics, to be sure.

Below we plot the vacancy-unemployment relationship, the Beveridge Curve, since 2000. The variables moved down and to the right during the previous recession as job vacancies fell and unemployment rose. During the recovery it has shown a counter-clockwise loop as it moves back up to the left. This movement is not unexpected as noted by the Diamond-Mortensen-Pissarides workhorse model of search unemployment. The vacancy data in this graph come from JOLTS, however, these data only started in December of 2000.

Third Quarter GDP Growth

The first estimate of GDP for the third quarter was reported on Thursday. At first glance it looks like excellent news because Q3 GDP increased at a 2.8% annualized rate in spite of the ongoing effects of the government sequester.  Personal consumption and investment both increased as well.  But, the 2.8% increase may not be cause for rejoicing.  A big part of this was a change in business inventories which increased $86 billion in Q3 and added nearly .8% to the Real GDP growth rate in Q3. Typically growth driven by a spike in inventories creates some backdraft for future growth as businesses work them off. It is also especially worth noting that these estimates are based on partial data, likely rendered less reliable than usual because of the government shutdown.

The Costs So Far

This has been most protracted economic downturn since the Great Depression of the 1930’s.  There are costs associated with this downturn that won’t be realized for years – the costs of disruption to the financial system, long duration unemployment, bankruptcies, collapsed household finances.  We can, however, take a crack at estimating the aggregate loss in Real GDP as we did in an earlier post.  To do this one has to take a stand on what the growth trend would have been had we continued on from the previous peak of the business cycle. Since this is unknowable we consider a couple of possibilities. This past quarter the GDP growth rate was 2.8% and this was the average rate from 1984 to 2013. Using that as a benchmark the cumulative output loss of the recession so far is 4,126.37 Billion 2009 $ or 26% of current GDP.

If we assume a larger long term growth trend – the average growth rate of 3.2% that prevailed from 1947-2013 – the cumulative output loss is even higher, at 9,345 billion of 2009 $ or roughly 60% of current GDP.  This is a loss of more than 10% of GDP or roughly $14,000 for each US household per year of the recession.

Other conservative estimates of the cost of the recent recession are similar (see here for instance). While we can debate about the future long term growth potential of the US economy, the loss in output alone stemming from the financial crises 6 years ago is staggering. Even if the growth rate in the 3rd quarter of 2.8% is sustained, the economy will never reach its previous growth trend, a fact that has yet to occur in post-war business cycles.

The BLS (after reopening from the government shutdown) released the Employment Situation report for September, leaving the broad landscape of the economic recovery pretty much unchanged. The Great Recession is still casting a long shadow over the labor market as employment growth continues to be anemic and the employment/population and labor force participation remain at the lowest levels in more than thirty years. As we noted in an earlier blog, the weakness in the labor market continues to play against the Federal Reserve’s earlier attempts to provide forward guidance about asset purchases and interest rates based on thresholds for the unemployment rate.

Non-farm employment increased by 142,000, below most economist’s expectations. The private sector added only 126,000 jobs, of which 100,000 came from the service sector: the largest gains in Transportation and Warehousing (23.4k), Retail Trade (20.8K) and Temporary Help Services (20.2K). Given that the next report will come out on Friday November 8  (less than a month from this report) and that it will be influenced by the shutdown, it is unlikely to be very informative.

While a 142,o00 monthly employment gain is well below ‘normal recovery’ standards, the pace of improvement in the labor market has been consistent now for several years. Most labor market indicators have either returned to their pre-recession levels or are slowly nearing them. Consider the growth in non-farm employment:

While the level of employment has not yet reached its pre-Great-Recession peak in nearly six years, it has been climbing steadily. The monthly net employment gain has averaged 179,000 since January 2011.

The unemployment rate in September ticked down slightly from 7.3% to 7.2%. Initial claims, obviously affected by the recent shutdown spiked up, but the trend down is also indicative of an consistently improving labor market.

Interestingly, labor productivity measured by total output divided by the total number of labor hours looks very similar to all previous recoveries except for the 2001 cycle. Even as employment fell 5% below its peak level, productivity continued to rise.

As has been the case for some time now, the Taylor Rule indicates that the federal funds rate should be significantly higher than its current level. The rule prescribes an interest rate policy given the how far unemployment and inflation are from their long run stated targets of 6.5 and 2 percent, respectively. If the targets are hit exactly, the Taylor Rule gives a 4% fed funds rate. Currently, the rule suggests a rate of around 2%, well above the zero bound where the fed funds rate has been since 2010.

The question is what exactly the Fed is looking at that suggests that there continues to be a sufficient need to keep interest rates near zero and the rate of asset purchases high. One labor market indicator that might be particularly worrisome is the employment to population ratio. The employment to population ratio compared to all other recoveries looks much different, it fell nearly twice as much and has shown very little recovery.

Indeed, the ratio is now about what is was back in the early 1980’s. Unfortunately, we do not have any way of really knowing what this ratio “should” be! The reason is that female labor force participation, baby-boom retirees, schooling decisions and a host of other things determine the numerator, not just how many get employed given they choose to work. In other words, it is by no means clear that it is expected to rise back to its level in the year 2000 or even 2007. Note, though, it appears to have stabilized over the past few months.

Another possible troubling trend is the relationship between unemployment and job vacancies, referred to as the Beveridge Curve.  Below we plot the vacancy-unemployment relationship since 2000. The variables moved down and to the right during the previous recession as job vacancies fell and unemployment rose. During the recovery it has shown a counter-clockwise loop as it moves back up to the left. This movement is not unexpected as noted by the Diamond-Mortensen-Pissarides workhorse model of search unemployment. The vacancy data in this graph come from JOLTS, however, these data only started in December of 2000.

The graph below uses a different data set (now defunct), the help wanted advertising index from the Conference Board, but we have only used the data from 1951-1998. This is the series that was formerly used by those looking at job vacancies before the advent of JOLTS. The colors indicate different decades. Ok, just as a quick quiz: Where are the 1950s on the graph and where are the 1990s?

The answer to the quiz can be found here. The point is that the outward shift in the  Beveridge Curve might come about for different reasons. First, as noted in the standard labor search framework, the counterclockwise movement comes about since firms can quickly post vacancies, yet matching firms to workers takes time. However, outward shifts can occur due to skill mismatch, here is an example, or changing demographics. It’s not clear which factor is causing the trend in the Beveridge curve since 2010, as it is also not clear what the role of monetary policy is in correcting the outward movement.