Getting the Unemployment Rate Down in Uncertain Times

By now you know that I am fond of simple analogies. Economics can be really boring to most people. When I learned macro it was all about five equation systems with reduced form solutions and stability conditions. Multipliers were the rage. I think we had equation-envy – how come nuclear physicists get to have all the fun? So with the help of Paul Samuelson and others, we economists can now bore to tears almost anyone at the best of cocktail parties. Of course, we can become almost orgasmic with our physics friends over a nice pińa colada and the Heisenberg principle. .

Okay, I also love to exaggerate. But there is some truth to this. President Obama understands that VEEP Joey B. and most members of Congress want things laid out plain and simple – unemployment bad; government rescue good. Now you may not be an expert in five equation models, but there is a little bit that macro can add beyond unemployment bad; government rescue good.

When I studied macro we started with the Classical School and subsequently covered Keynes, Keynesians, Unreconstructed Keynesians, Neo-Keynesians, Monetarists, New Classical Economics, Supply –Side Economics, and JoeBidenism. I am just kidding about the last one – but all the rest are real. What was the point? Was it like a religion course where you needed to understand all the religions of the world so you could choose one or more religions that maximized your chances for salvation? I don’t know, but I think all those schools of macroeconomic thought helped us focus on the many reasons why macro and macro policy are so complicated and controversial.

Dr. Smith thinks my fainting spells are caused by a serious internal blood flow issue. Dr Jones thinks I have a mild case of the flu. The body is a complicated thing. It might take time to study the symptoms, how medicines work, and perhaps time for a little exploration inside the body. Finally the two doctors agree on the problem but then they might have different opinions about the remedy. Let’s use drug X or let’s wear compression pants. I don’t know but hopefully you are getting the point. Why should Macro be any simpler than the anatomy of a human body? After all, what we mean by macro is the summary results of all the millions or billions of interactions between buyers and sellers, and investors and renters and workers and executives and Congressmen, and so on.

We usually break down the economy into segments or markets for labor and other inputs, goods and services, money, bonds and other financial, and so on. Decisions in each market respond and react to each other. A financial change impacts interest rates. But since spending on goods depends on interest rates, a financial impact spills over into the market for goods. Firms produce more goods and that has implications for the labor market and employment. And so on. It is fun. Inverting a matrix is really cool too.

Theory helps us understand how these markets and their participants respond to stimuli. The past helps us to understand HOW MUCH they usually respond. It is very complicated – and the outcomes for tomorrow are not always going to be exactly like the results from yesterday. Though we like to think we incorporate everything important in our macro analysis – the truth is that the economy changes over time – and therefore the HOW and the HOW MUCH changes too. Controlling and forecasting the economy is like trying to hit a moving target.

This last paragraph gets me a little closer to the subject of this harangue – unemployment. Our experts keep telling us that unemployment is a lagging indicator (it must have been sleeping in school) and that in this recession, it will be even more lagging. What a laggard! How can that be? Are we suffering from some bad karma (polyester suits of the 1970s?) Why is it so much slower to adjust than in the 2001 recession; than in other recessions?

Well maybe because those past recessions were different from this one. What wisdom you learn here! What is different about this one? First, it wasn’t your usual-run-of-the-mill Main Street induced slowdown in spending. It was not particularly your 1970s supply-side contraction either. While Main Street did get impacted, the onset was a problem in housing markets that spilled over into financial markets…and then to Main Street and the Champs Elysees, Unter Den Linden, Oak Avenue and lots of other streets around the world. Second, this recession which started at the end of 2007 scared the crap (sorry about the four-letter words – please don’t let your teenagers read this) out of most of us and then when the politicians started wringing their hands on television – it REALLY scared the crap out of us. Japan had a similar kind of recession a long time ago – and some experts think they never did permanently exit it. Third, we hosed this fire with a lot of cannons. We doused it with tax cuts, spending increases, and enough money to run China for about 20 years. Most of this effort was aimed at revving up spending by consumers. Let’s buy a few more cars and houses folks. Being a good American, I chipped in heartily to the retail liquor industry – with several large bottles of Jack Daniels. Fourth, we managed to combine all this action with a health care reform, financial reform, and energy policy. The upshot of much of this policy is that some social goals will have been advanced and business and high income people will be asked to pay for it. The debts are staggering.

They can argue all they want – but let’s face it – no one thinks that the combined impacts of all that legislation had much positive impact on employment. Firms have produced and earned a little more but they have not yet felt compelled to hire many new workers. Would you? The economy is complicated and it really isn’t clear that the government improved the situation. Profits have recovered but could not possibly have erased the losses of the past couple of years. In fact, it is clear that the government has imposed some significant cost increases and regulatory burdens on firms. The government has also created an adversarial environment for many business firms – BP is only the latest victim of superficial populist government finger pointing. Of course, when it comes to the housing and financial problems that STARTED all the negative stuff – the government still hasn’t done enough to instill confidence.

What’s the point? The point is that none of this is very simple and we find ourselves in a new situation in which the past is not a lot of help. It reminds me of a pinball game with about 50 balls all careening around the table. How and where it will end, no one knows. The bottom line is that between the past macro shocks, the recent macro policies, and the expected future macro policies – we have a perfect storm of UNCERTAINTY. Unemployment is not going to improve until the uncertainty subsides. We are left with a tantalizing question that I’d love to pose to Keynes – given this environment in 2010, is the solution to reducing uncertainty more government policy or less?