Tuesday, May 5, 2009

Will Fewer Have Jobs When The Economy Is At Full Employment After Recovery?

Some economists are reconsidering what will constitute "full employment" - the unemployment rate at which the inflation rate does not change positively or negatively - after this slump ends. From Bloomberg:
Post-recession America may be saddled with high unemployment even after good times finally return.

Hundreds of thousands of jobs have vanished forever in industries such as auto manufacturing and financial services. Millions of people who were fired or laid off will find it harder to get hired again and for years may have to accept lower earnings than they enjoyed before the slump.

So far, so good. Since unemployment is generally a lagging indicator, it seems likely that even after the economy stops contracting that the unemployment rate will continue to climb. Furthermore, sectors that were overbuilt during the bubble - autos, real estate, and finance - will lose jobs that will not come back. But what does this mean for full employment? Back to the article:

This restructuring -- in what former Federal Reserve Chairman Paul Volcker calls “the Great Recession” -- is causing some economists to reconsider what might be the “natural” rate of unemployment: a level that neither accelerates nor decelerates inflation. This state of equilibrium is often described as “full” employment.

Fallout from the recession implies a “markedly higher” natural rate of unemployment, says Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel Prize in economics. “It was 5.5 percent; maybe it will be 6.5 percent, maybe 7 percent.”

This is certainly possible, but it seems like an optimistic reading of the situation. An unemployment rate that peaks somewhere around 11-12 percent and then recedes to 7 percent for the foreseeable future could also act as a powerful deflationary force on the economy. If banks begin to lend out some of the gargantuan excess reserves they hold, this could prop the economy out of deflation despite the relatively elevated unemployment level. In this context, the number of people working when the economy is at "full employment" could fall. But if the Fed tightens monetary policy, the inflationary impact of any credit expansion would dissipate, and the US economy could very well teeter along into deflation again.

Let us hope that we get high unemployment and inflation: the alternative is far worse.

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