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.

Deflation Alert

CPI down 0.1%. In the twelve months ending in March, prices declined 0.4% - the first yearly decline since 1955. How long will goldbugs continue to insist that ending up like Weimar Germany rather than USA circa 1933 is the real danger facing our economy?

Switzerland Falls Into Deflation

As Ambrose Evans-Pritchard notes, Switzerland is the latest country to join the deflation club. Swiss CPI fell 0.4% in March on a year-on-year basis, and is projected to fall to -1% by July. The Swiss franc's status as a currency safe haven has exacerbated this downward pressure, as the franc has gained value, driving the value of imports down, and hence forcing domestic goods to become cheaper as well in order to compete. The Swiss National Bank (SNB) has promised to aggressively move to lower the exchange rate to counter this threat, raising the specter of competitive devaluations. Evans-Pritchard explains:

Yet even the SNB's hard men have thrown away the rule book, taking emergency action to force down the exchange rate of the Swiss franc.

Here lies the danger. If other countries try to export deflation by this means, we will face a second phase of the global crisis. Taiwan is already devaluing. Korea, Singapore, and Sweden all seem tempted to follow. Japan is chomping at the bit.

"We don't fully realise in the West what a catastrophic collapse Japan has suffered," says Albert Edwards, global strategist at Société Générale. "The West has dumped a large part of its economic downturn onto Japan by devaluing against the yen."
This is about to go into reverse as Tokyo hits the ping-pong ball back across the net. "As the unfolding collapse in the yen gathers pace, the West will see its green shoots incinerated to dust," he said.

By devaluing, a country makes imports more expensive, pushing up prices across the economy. There is a concomitant fall in prices abroad, as the country's exports become cheaper, pushing down prices with its trading partners. But this only works if it is pursued individually. If a host of countries try to gain a competitive advantage by devaluing, then there is a race to bottom that nobody wins. Relative prices between exports and imports remain the same, while the prices of real assets - commoditites, real estate, and stocks - jump. This is a path towards mutual ruin. Because wages are sticky, households will find it harder and harder to pay for the basics of housing and energy.

Will world leaders - particularly from trade surplus countries where there is an incentive to export troubles away - be able to organize the type of collective action necessary to avert such disaster? Not likely.