Unemployment and Government Deficits

 In October of this year the unemployment rate got down to 4.6%. It had been below 6% since 2015 until Covid helped cause the rate to go back up to 8.1% for the year. So I started thinking about the unemployment rate. 

Before I start blabbing about the numbers let's admit one thing. The unemployment rate is a wild and crazy animal. I printed out the average annual unemployment rate for each year between 1961 and 2020. Those of you counting on your fingers and toes, that's close to 60 years. 

It is a wild and crazy number because its construction brings a lot into factors into the number. It is a rate because it takes the number for the labor force (employed people and those looking for work), subtracts the number of people who are employed, and then expresses that number of unemployed people as a percent of the labor force. Lots of things can cause that number to move around and it does. 

For example, the unemployment rate was 4.6% in 2006 and then by 2010 it had risen to to 9.6%. By 2017 it was back to 4.4%. Bouncy bouncy. 

Falling asleep yet? 

The unemployment rate catches a lot of attention. Perhaps it is the bad-boy (or girl) of the Bureau of Labor Statistics. When it rises, we get anxious or downright unhappy. A higher unemployment rate is taken to be a sign of weakness in the economy. When the unemployment rate rises enough, our government ears perk up and we wonder when and by how much we should stimulate the economy. The government often wants to spend more and tax less as a way to goose the economy along. Get it rolling. Thus we find that unemployment changes trigger changes in the government budget deficit. 

We see causality in the way of unemployment increases causing increases in government deficits. Of course, it isn't that simple because sometimes the causality is the opposite. For example there are times when a rise in government deficits are successful -- a rise in the government deficit causes a reduction in the unemployment rate. So we are left with two possibilities when we look at the data. 

A. Increases (decreases) in the unemployment rate cause increases (decreases) in the government deficit

B. Increases (decreases) in government deficits cause decreases in the unemployment rate.

Which is it? Do the two variables move together or do they move opposite to one another? 

The answer is -- BOTH are true. 

That's why I wanted to look at the numbers. 

From 1961 to 1969 the unemployment rate fell from 6.7% to 3.5%. How low can you go? The government deficit* bounced around but showed no real trend during those years. 

The unemployment rate did not stay at 3.5% for long. It kept rising from 3.5% in 1969,  peaking at 9.7% in 1982. You would think that the government would call in the fire trucks and they did. The government deficit which had been at less than $3 billion per year rose to $48 billion by 1983. The government was clearly using its financial tools to bring down the unemployment rate. 

It took a while to percolate. From 1983 to 2000 the unemployment rate behaved and kept falling until it bottomed at 4% in 2000. By around 1997 the government deficits began to fall as the government perceived less of a need to stimulate an economy that was doing better.** In 1998 we had a government surplus and that continued until 2002 when the government went back into the red. 

In 2002 the unemployment rate jumped to 5.8%, stayed high, peaked at 9.6% in 2010 until it returned to about 5.3% by 2015. As the unemployment rate was rising, the government jumped into action again. From a surplus of $24 billion in 2000, they moved us to a $100 billion deficit in in 2004 and by 2011 they had the deficit up to $313 billion. The deficit stayed in the hundreds of billions.

All that stimulus worked for a while -- the unemployment rate declined to 3.7% by 2019. 

Where are we now? Covid and resulting economic imbalances left us with an unemployment rate of 8.1% in 2020 but as of October of 2021 it had fallen to 4.6%. Records show that the government deficit was $837 billion in 2020.The largest previous deficit was $318 billion in 2010.  The government seems quite willing to continue the stimulus despite the dramatic improvement in the unemployment rate in 2021. 

The history of unemployment and government deficits suggests that the government is probably not finished yet. There is also the unpredictability of Covid and its impacts. I am guessing they are not done with large deficits. Large deficits with falling unemployment could spell higher inflation.

Perhaps I will try to being inflation into this discussion next week. 

*The government budget numbers quoted here are from the Bureau of Labor Statistics. They are nominal figures meaning that the effects of inflation have not been purged. There is some worry that relating nominal deficit figures with real unemployment figures is not the optimal approach. But I am not sure that deflating the government budget figures would produce a different result. 

** As the unemployment rate rises it may cause a policy response. As the unemployment rate rises, it may affect the deficit without legislation since it means less employment, less income, and less tax revenue. In either case a rise in the unemployment rate causes an increased government deficit. I don't split this hair in the text.