Favorable Signs of a Sustainable Economic Recovery
"Unemployment is as high as it has been in 26 years, and it is not likely to fall significantly for some time to come. Believe it or not, that's good news, if "good" can mean continued hard times for millions of Americans. No one is expected to cheer if, in the months ahead, news analysts keep talking about stubbornly high jobless rates, but a sluggish rebound in the jobs market could very well be the engine for a sustained period of robust economic expansion down the road."
The dynamics distill to a trade-off between timeliness of the recovery in the jobs market and inflation. An unemployment rate dropping too rapidly will ignite inflation, and the cure for inflation coming fast and furious would almost certainly throw the country right back into recession.
The graph below, drawn from the Bureau of Labor Statistics database, shows the corrosive effect on per-person output of the recession that is now ending and how the beginning of the recovery was led by the first increase in productivity since the beginning of 2008. For the second quarter of 2009 (the most recent for which data is available), the index of output per person in the manufacturing sector rose from 173.162 to 175.164, as workers still employed were pushed to produce more.
This goes right along with what I wrote in "Recession to Recovery: The Rough and Narrow Road Ahead":
If [businesses restock declining inventories] with their existing workforces and maybe a modest increase in new hires, the workers doing their jobs will work harder, and the companies will see their profit margins start to improve as the inventories are sold; but if the companies have to hire lots and lots of workers to rebuild inventories, competition for qualified workers will heat up, and companies will have to start bidding up wages and salaries.
So far so good. Productivity per worker is going up, and this is happening without any increase in the overall rate of employment, which means it's the already employed workers who are pushing harder at their jobs. (That, of course, is not great news for working people, who are quite likely feeling as if they're being flogged to greater productivity in the national ship's slave galley right about now.)
What about labor costs, though? If this really is shaping up as a strong recovery, the other part of the equation, worker pay per hour, should be holding steady. In fact, labor costs had risen dramatically right before this latest recession in a typical Keynesian catch-up with other price increases earlier in the 2001 to 2008 economic expansion; but they have now leveled off, staying almost flat from the first to the second quarters of 2009, as indicated in the graph below.
That means wage inflation is in check for the time being, so as other prices rise, workers will have to continue delivering greater productivity to hold on; and as long as businesses don't have to start furiously competing with higher wages for new workers, the unemployment rate can be brought down slowly without triggering the inflation spiral I described in "Recession to Recovery."
So, bad news really is good news, at least sometimes. Unemployed people really are suffering, and that is where public policy projected through assistance programs can blunt the damaging effects of joblessness and all the problems it creates for people, families, and communities.
We have the makings of a sustainable, strong economic expansion. The figures provide clear evidence of this, but the story isn't finished. Once the expansion gets its own momentum, the central bank of the United States will have to turn its attention away from providing liquidity to keep interest rates low and start the long, difficult process of draining from the economy an incomprehensibly large overhang of dollars that has been accumulating year after year, starting early in the current century.
That excess liquidity is much like a tidal wave still well out at sea. That rolling, roiling mountain of rising prices is headed right for shore, and if the unrelenting swell of pounding surf is not drained away long before we see it, the resulting inflation will be a debilitating, destructive force that only the most draconian and protracted of contractionary monetary policies can stop.
The question yet to be answered is whether or not there will be enough time: the economy must gather sufficient upward momentum to no longer need extraordinary stimulative spending by Congress accommodated by extraordinary liquidity provided by the central bank. If the Fed starts draining the dollar overhang too soon, the economic recovery will be slowed or even stopped; but if the Fed waits too long, the inflation spiral will be so embedded in labor and business expectations that the contractionary monetary regime will, once again, slow or even stop the economic recovery.
In a worst-case scenario where the Fed waited too long to face the inflation problem, the eventual clamp-down on the money supply would have to be long enough in duration to potentially be economically devastating as well as politically disastrous to the incumbent President and members of Congress, who would almost assuredly be blamed by the electorate for the collapse of the economy back into recession.
Right now, it looks like a controlled rollover by the Fed away from accommodative monetary policy can still be accomplished in such a way that the nascent economic up-swing can be sustained.
Unfortunately, the size of that tidal wave of liquidity mentioned above is not really appreciated by most people, and maybe not even by most policy makers in Washington. It is out there, still well over the horizon. It's coming; and just like tidal waves on the ocean, which have the odd habit of making the tide go out right before the massive wave hits, the dollar overhang will have the perverse effect of creating sporadic evidence of deflation in the months before the inflation comes in as a relentless force driving commodity prices, wages, food prices, and interest rates upward.
If it gets to the point where our public policy officials are fighting the tidal wave at the shoreline, we will have a hard, debilitating battle, indeed.
We should hope that our leaders in Washington will seize the opportunity now available to deal with the impending challenge before they have to manage an inevitable disaster.
Recession to Recovery: The Rough and Narrow Road Ahead
We still have incomprehensibly large work to do to reform and modernize financial and public institutions, and politicians on both sides of the aisle will do anything and everything they can to avoid taking on the underlying problems.
It is not just the public sector that is excitedly declining the opportunity to reform rather than repair long-standing, self-destructive policies; but neither those who hold elected office nor those responsible for the safety and security of their own households seem permanently committed to relying less on debt and more on a certain degree of character-building austerity.
In these very tentative steps of the newly born recovery, the numbers will swing between bad and good. On some days it will sound from the news stories like we're still in a recession. The most difficult part of this recovery to explain to the average person is that some of the bad news will actually be good news, at least for the long run, and some of the good news might be cause for quite a bit of concern.
Unemployment is as high as it has been in 26 years, and it is not likely to fall significantly for some time to come. Figures released earlier this week indicate that the labor market is still suffering: unemployment rose in September to 9.8 percent from 9.7 percent in August.
As counterintuitive as it might sound, that's good news, if "good" can mean continued hard times for millions of Americans. While no one should be cheering if, in the months ahead, news analysts keep talking about stubbornly high jobless rates, a sluggish rebound in the jobs market could very well be the bellwether indicator of a sustained period of robust economic expansion down the road.
The Great Depression opened the doors of national political dominance to the long-backbenched Democrats, led by Franklin D. Roosevelt, the President of the United States who brought with his administration a new kind of economics, set forth by a man named John Maynard Keynes. We call his economic policy prescriptions "Keynesian economics," and greater or smaller tools in the Keynesian relief kit have been used by both Democrats and Republicans ever since. In theory, the policies distill down to some relatively simple ideas. In recessions, the government should run deficits by cutting taxes, spending money on jobs programs, helping the poor and unemployed, and generally stimulating the economy. In boom times, the government should pull back on all the fiscal stimulus by raising taxes to keep the economy from running too hot, pay off the federal debt, and build a surplus; and the government should back off all the generous jobs programs, big benefits, and grandiose public projects, at least to some extent.
This is called "countercyclical policy," and although it has had an unfortunate bias toward stimulus even in good times, it has unarguably served to greatly shorten the boom-bust business cycles, make recessions quite a bit milder, and cause the periods of expansion to be considerably longer by comparison.
It has a dark side, though, and even Keynes, himself, described the crucial nature of this part. He described a phenomenon he called "sticky wages," the tendency of compensation to labor to lag behind rising consumer prices and rewards to other factors of production. This stickiness is critically important because, if prices are rising all around people, but their incomes are not going up in lock step, they will have to work longer and harder to maintain their lifestyles, pay their fixed obligations, and keep their lives running relatively smoothly. It is this rising productivity that propels the economy into a period of expansion without inflation being fed by rising wages and salaries.
That means, if we see the unemployment rate falling too fast in the coming months, the economic recovery will be stymied before it gets momentum, and here's why. A recent statistic released by the government showed that business inventories are falling, and if this trend continues, companies will have to start boosting output levels to restock. If they do this with their existing workforces and maybe a modest increase in new hires, the workers doing their jobs will work harder, and the companies will see their profit margins start to improve as the inventories are sold; but if the companies have to hire lots and lots of workers to rebuild inventories, competition for qualified workers will heat up, and companies will have to start bidding up wages and salaries.
A rapidly falling national unemployment rate will sound like good news at first, but once wages and salaries start catching up with other rising prices, that means inflation will have begun to take on a life of its own because those rising compensation levels will give households more money with which to buy goods and services, and the increasing demand pressure will start pushing prices at the consumer level up even more. Making things even worse, that building demand by households for goods and services will induce businesses to hire even more workers to keep up with the demand that's clearing inventories at an increasing rate.
More workers being hired means more wage and salary increases, which means even more demand for final goods and services, and the cycle begins to take on a self-feeding inflationary aspect.
But all of that is only the prelude to the real problem: inflation, as mean and annoying as it is, pales in comparison to its muscular after-shock, which is expected inflation.
The central bank of the United States is called Federal Reserve, or the "Fed" for short, and one of its most important responsibilities is to conduct monetary policy. If it allows the growth rate of the money supply to exceed the real growth rate of the economy, that so-called "excess liquidity" will eventually become inflation, since each dollar's value will be watered down, meaning more dollars will be required to buy things. When the Fed wants to help the government pull the economy out of a recession, it will print money at an unusually high rate and use that money to help fund the government's deficit spending. Done right, the Fed can then drain that excess liquidity back out once the economy gets back on its feet. But therein lies the tricky part: interest rates are the "price" of money, so if the Fed, in its effort to prevent inflation, reduces the supply of money too fast, interest rates will rise too much and too quickly, and the economic recovery will be killed in its tracks. We've probably seen this happen in the past. The result is called a "double-dip recession."
On the other hand, if the Fed acts too slowly to claw the overhang of dollars out of the economy, the inflation lingers long enough for both businesses and workers to start expecting it, which means everyone will be pushing up their prices because they want to get in front of everyone else pushing up their prices. This makes the Federal Reserve's job of stopping inflation quite difficult: not only does it have to drain the excess liquidity, but it also has to hold the choke for a while longer to convince businesses and labor that it is serious.
That was what happened in the recession of 1981-82: years of expansionary monetary policy had caused inflation to get so severe by the end of the 1970s that no one believed the Fed would finally deal with it once and for all. So when President Jimmy Carter appointed a tough guy named Paul Volker as Chairman of the Federal Reserve, Mr. Volker had to throttle down the money supply fast and hard, which drove interest rates through the roof, and he had to hold the money supply down for months and months until not only was all the excess money drained out of the economy, but also the entrenched expectations of inflation were flogged out of planning by businesses and labor.
As a side note for history buffs, Jimmy Carter was defeated in the presidential election of 1980. Therein lies a cautionary tale for our current President, Barack Obama: it's good to do the right thing, but if there's going to be pain involved, it's better to do it considerably before voters go to the polls. Unemployment isn't just for the private sector.
Returning to the present, we have a large overhang of dollar liquidity swirling through the economy. Some of this is the result of recent Fed activity to support the economic stimulus package enacted earlier this year, but a huge amount is the result of years of expansionary monetary policy to help pay for year after year of federal budget deficits. (The share of the deficits not covered by the Federal Reserve's money printing machines has been picked up in large part by foreign central banks that hold American dollars earned by their businesses exporting more to us than we sell to their people.)
The money the Fed has printed in excess of what was needed for transactions among businesses, consumers, investors, and workers in the American economy is the liquidity that has to be drained out because it will be the fuel for a spiraling inflation. If the Fed starts that grim work too soon, interest rates will rise rapidly, and the U.S. economy will nose over back into recession; but if the Fed waits too long, seeping inflation will become a flood as unemployment drops too quickly, causing wages to join other prices going up, and the economic recovery will evaporate into a spiral of inflation that will push up every price, including the price of money, which is interest rates.
Inflation-driven increases in interest rates will stagnate the economy, and we will again have, as we did at the end of the 1970s, a bad economic situation called "stagflation," for which the only cure is the old-time gospel of tough, sustained, contractionary monetary policy, which will drop us into another painful recession.
Is this the inevitable path of the current economic recovery? Certainly not.
As long as the unemployment rate drops slowly, the Federal Reserve will have time to keep interest rates low for a while longer to let the economy get back on its feet, and as long as the Fed's eventual pattern of draining the excess dollars out of the economy is carefully planned and not the result of panic-driven work to stop an already-building inflation spiral, we can have a recovery that becomes a genuine economic expansion with reasonably stable prices, sustainable growth in American jobs and, with that, more tax revenues to help close the large federal budget deficits we are now running to get us out of this recession.
It might require the proverbial wisdom of Solomon for our leaders in Congress, the White House, and the Federal Reserve to execute the necessary economic policies at just the right times, but we must hope they know what they are doing and have the will to carry through with their responsibilities.
While the road ahead for American workers may be difficult for some time to come, a sustained economic expansion serves not just our own interests, but those of the generations that will benefit after us.
As much as we want a solid foundation upon which we, ourselves, can stand, we must also appreciate that we are building a bridge to the future for our children. That bridge should be not only strong enough to support their needs, but also wide enough to accommodate their hopes.