Monday, November 21, 2016

7 Pitfalls For Donald Trump

7 Pitfalls For Donald Trump

The order of policy implementation matters...Trump will get it wrong.
Trade tariffs and competitiveness- The reason NAFTA fails and China obstructs  
Tax-cut stimulus to be haunted by the 47%...remember them?
Infrastructure stimulus: loved but lacking
Success depends on whether it’s a ‘U-6’ or a ‘U-3’ world
Reality bytes – tech remains a problem for jobs
Demographics, trade, and the 47% stalk the multipliers
See full article at link below

Tuesday, October 25, 2016

Fed rate hikes matter

Fed rate hikes matter

There are two extreme schools of thought on the Fed. One is that because of the size of its balance sheet it controls everything: the level of interest, the yield curve, all of it. Another view is that the Fed does not matter because the market still can poke through the veil of secrecy and get rates where it wants them. If the Fed has a different view from the market and it lower rates too much the market will steepen the yield curve. If the Fed over tightens, the yield curve inverts to compensate.

Reality- Between these two extremes there is the reality which I believe is that the Fed sets the short rate and influences the long rates – how much influence remains a matter of debate. But I do not think that the Fed pegs all rates yet it does disrupt many of them in a way that may render the yield curve and the rate spreads as much less useful barometers on the markets and on the economy compared to more ‘normal’ times. Markets can be fooled by what the Fed does and says and markets can be misled as well.  

Mystifying monetary policy- With the economy fragile, growing slowly, productivity weak, inflation still undershooting and the outlook uncertain, it would not be a good time for the Fed to mystify markets but that is what it seems to be headed for.

The WSJ view as an example of what is wrong- A recent WSJ article (here) just jumbled together the ideas of the Fed guiding markets, communicating clearly, and having made up its mind about December while fluffing past the notion of the Fed being data-dependent. 

Two schools on the Fed- Interestingly a number of Fed critics think that the Fed is doing the economy a disservice by keeping rates so low. Another group fears that the Fed is ready hike them too soon or too quickly or by too-much altogether. I am in that latter group.   

The 2015 paradigm- In my view, the Fed got itself into trouble in 2016 by what it did at the end of 2015- hiking rates prematurely.  Amid great fanfare, calling the period of special accommodation over, the Fed raised rates in December about 10-months ago even though its own stipulations for a rate hike had not been met. But since many (all!) Fed officials had said at one time or another last year that they expected to raise rates in 2015, the Fed felt obligated to do just that – even though to do it required that the Fed violate its own rules. To accommodate and justify that rate hike that the Fed claimed to make policy based on its view of the intermediate term and where it ‘deemed’ growth, inflation rates and unemployment were going. That is how, with oil prices in the midst of spiraling lower and lower, the Fed was still able to move to hike rates in December of 2015. That is something that will always look like a really foolish mystery to future Fed historians. How could the Fed think it was on path to meet its inflation objective with oil prices in near freefall?  

The 2016 question: Now what is the Fed going to use to justify a rate hike in December 2016? It will pass on a rate hike in November because of the elections but will state a different reason. That is allowable central bank misdirection. But (a) with growth still weak, (b) inflation under shooting - (c) not accelerating- and with (d) the unemployment rate having stopped its relentless move lower and (e) having backed up from its lows, what will be the Fed’s excuse/reason for hiking rates this time?  

And why does it make a difference?

Why rate hikes make a difference
International fragility and feedback- While the Fed has from time to time talked about the importance of the international economy and on two occasions in the past year actually swerved policy (allegedly) for international reasons, the Fed’s expressed view of the importance of the international economy misses the point. The point is not that international turbulence should stay the Fed’s hand (Sept of 2015 and early 2016). Nor is the point that Brexit was a risk and a reason for policy to hit the pause button. Not that I am not arguing that those decisions were wrong, just that they miss the point. Yellen has talked of how monetary policies are more connected in some way which is curious because under floating rates monetary policies are supposed to be more independent. But that is getting somewhat closer to the point.  

Structure, impact and policy diffusion- There are several aspects on internationalization that the Fed seems to almost completely ignore. The first (1) is the way in which trade already had changed the structure of the U.S. economy and made it more vulnerable. The strong dollar already makes it hard for the U.S. to produce anything at home for export or even in competition with imports. Technology should be an equal opportunity disruptor but it has disrupted the U.S. more because of its high wages and uncompetitive exchange rate. A Fed rate hike (2) will make all that worse by moving the dollar higher, making it even less competitive. But that is not all it will do, (3) a stronger dollar will drive up the foreign currency cost of all commodities, oil included, and that puts downward pressure on dollar prices. A strong dollar will spread the U.S. rate hike globally; it is globally deflationary at a time that other central banks are trying to jump start inflation. Is that a good idea?  In summary, I am concerned not so much about the Fed hiking rates and about that impact on the US economy as I am concerned about the feedback effects in the international community

And it is  NEVER about just one 25bp rate hike-. However, do not dismiss the prospect of a Fed rate hikes as unimportant at home. Many have asked, “what’s the trouble with one 25bp rate hike?” Well that was December 2015 and you tell me, “what followed?” It was one 25bp rate hike… followed by chaos. Some of that chaos was Fed-generated as Stanley Fischer came forth with his great theory of why the markets were wrong and what the Fed would really do. Stanley will still be eating crow for Thanksgiving this year (…with a wonderful dessert of humble pie) he has so much stocked in his refrigerator after that dead wrong analysis- road-kill crow.

Fed fears make for bad policy moves- And that is just another reason why we should be wary of Fed policy pronouncements or forward guidance: the Fed simply is making it up as it goes along. It has little wisdom to impart, and worse, members have an agenda. They now fear anything from inflation to bubbles. They are not sure which is worse but they are sure that this will end badly and that there is something to fear and nothing like slamming policy into reverse to fix it.  

Not Ptolemy Copernicus or Kepler: the Big Bang radiates! -  Rates are important. Interest rates sit at the center of the international economy’s perceptions. They impact exchange rates. They are links to current and future consumption and investment. They have a role is setting inflation expectations. This is the last place that the Fed needs to be spreading mischief. If it is appropriate for the U.S. to raise rates it should be sure – very sure- because there will be repercussions of a significant nature from abroad, too. Last year’s hike should have made that clear. But I get the sense that the Fed has not learned much from that episode and instead treats it like a one-off event instead of like the endogenous response to the Fed’s own actions that it was.   

A mind is a terrible thing to waste…a waist is a terrible thing to mind…In short I fear that the Fed has grown and learned very little. It still seems to regard its new tool box as adequate, or it is willing to act as though it does. It seems to be willing to be bold with policy and inventive with its forecasts despite the economy’s circumstances and its past lack of forecast ‘suck-cess.’ In the guise of lifting rates to get away from the zero bound threat the Fed is flirting with that very problem and may force us to deal with it very soon instead of just to think about it hypothetically. Rate hikes are important because they are dangerous. Play with fire at your own risk. Ask yourself this…if there were no Fed what would the markets be doing with rates in this environment?  I don’t think that marching higher is a likely result. Do you?         

General central banking rules-  

My bottom line is that the central bank should have reasons for what it does. It should make these reasons known and be true to them. If it expresses a model or point of view its policy enactments need to be consistent with that view. Central bank policy should not cram the square peg of policy change into the round hole of what I said I’d do. Policy should be easy to understand and should not take much hairsplitting to explain why the bank acted as it did. Policies should flow freely out of the central bank’s policy ‘map’. No right hand turns from the left hand lane.     

Monday, July 4, 2016

Draghi’s dilemma delivers depressing

Draghi’s dilemma delivers depressing dilly

Mario Draghi has an idea. Well he has a fragment of an idea. He has a fragment of an idea he would like to turn into a policy initiative someplace.  His idea is that countries should be careful about transmitting distortions overseas from their own policies because they are growing at different speeds. It has some basis in fact but also a vague scatterbrain cast to it like a Saturday Night Live spoof of a real policy maker’s speech. He must have been in an amazing state of denial when he thought up those remarks…here they are:

“In a globalized world, the global policy mix matters—and will likely matter more as our economies become more integrated,” Mr. Draghi said. “The speed with which monetary policy can achieve domestic goals inevitably becomes more dependent on others.”
-- Mario Draghi

Draghi rambled on because he did not want to say directly what he was directly thinking. So he rambled on and tried not say what was really on his mind, that was of course:

Please don’t hurt me!  

He was worried about that villain of international monetary policy, Janet Yellen and her monetary policy plan to hike rates in 2016…to do it as much as four times. Reverberations from that would wrack the EMU economy. But of course a central banker can’t single out a fellow banker so he spoke in these broad generalities, in vague generalities. He tried to make it sound like something academic or rhetorical maybe a theoretic construct.  He tried that but it came out sounding very confused and whiney.  

That is because it was illogical and confused.

Some background…
The G-7 had a go at trying to mutually manipulate exchange rates. They gave that up for the notion that each country would run the best policies it could for its own economy. But now that is not working either. The world trading system is broken and so this is the sort of thing that will happen.  

Now with the ECB’s back against the wall and the Germans holding the key to the lock box of fiscal policy Draghi is without options. He is doing QE and interest rates are negative. He has even appealed for more efficiency. He is afraid that rate hikes in the US could swamp him like a man in a small dingy as a freighter goes by. Please make no wake. But the problem here is not with the potential wake maker. It’s with the guy in the dingy who has no business being there.

The idea that the US is at fault for wanting to hike rates seems preposterous: US inflation is low but climbing and the unemployment rate is quite low. Yet, the fact that the US is the one more at risk because Europe has launched a policy of negative rates is, in fact, much truer but almost never voiced.  Money is pouring into the US pushing rates down at time that they might be better served going up. Why should the needs of the European business cycle take precedence over the needs on the US business cycle in the making of US policy?

Riddle me that one bat man...or super Mario. Where does this idea come from? What is its precedent?

Arguably ECB policies have been much more distortive to global events than US policy. Although with the dollar as a much more powerful reserve unit, and the numeraire for commodity prices, its potential to spread its effects globally takes on greater impact when the Fed moves. Higher U.S. rates would send a deflationary chill across the rest of the world and, in this environment that could be enough to make a difference. I can understand Draghi’s fear. But does he really want to influence the conduct of US policy?

First of all the idea of a US policy move is fanciful –still only hypothetical- while the EMU negative interest rate policy is a reality. Their reality is affecting the US economic situation and the US policy-trade-offs. And so what is the US supposed to do? It is in a different position in its business cycle than Europe. Should policy stand still and let bad stuff happen in the US? Germany is actually a member of the EMU and what is it doing with its own substantial fiscal flexibility? How much is it helping its own cause? (i.e. zero).

It is not clear to me at all what Draghi expects or why except this...

Don’t hurt me, Janet. Please…  

Draghi did not say anything profound. He offered no resolution to any problem. In fact he seems to have made something up… Why does Europe’s policy goal become more dependent on overseas events necessarily? There is a business cycle conflict and we have had countries with business cycles out of sync before. One thing EMU/EU could do is use fiscal policy. But the Germans have put that off limits and because of that the US needs to alter its money policy to fit into Europe’s policy pickle?  Frankly I don’t get it. I don’t see it. And I think it is an example of how fouled up Europe has become. At the European Summit members were gaming Scotland about its EU ambitions to aggravate the U.K. But instead they aggravated Spain that has its own separatist regions to be concerned about and quashed the notion of making an offer to Scotland for its own reasons. These bureaucratic machinations are unbecoming of a major currency bloc. Its leadership is showing their pettiness. The EU should be focused on what it can do to help the ECB instead wasting energy trying to make the UK miserable over Brexit.  

Europe seems to see its problems as exacerbated by what everyone else does. The UK’s Brexit decision has Europeans hopping mad. US monetary policy is causing them problems. Of course, their own inaction in the Middle East allowed ISIS and the migrant problem to get out of hand. Europe wants to blame Greece for being a migrant entry point, but what can Greece do?

At some point Europe has to face the music, take its share of the blame, and choose among the policy options it has. Taking policy options off the table is not a good idea. But the Germans and much of the rest of EMU have different ideas about policy. Germany is engaged in a show of force to make the rest of Europe pay for past fiscal transgressions. Europe is being disciplined by Germany and Draghi wants the US to take off some of the pressure. Meanwhile, European bureaucrats are playing stupid tricks on one another as Italian banks are reeling from a post Brexit stock sell-off. Here again Europe wants the Italians to follow-the EU protocols on bank bailouts. Renzi has all but given them a Bronx cheer on the notion of letting shareholders step up to feel the pain, that - THAT – is not going to happen in Italy. But what will happen is still unclear.

Isn’t that interesting? None of it bodes well for the future. Markets may be settling down in the Brexit as a reality era. But there are still lots of hurdles to go over and it seems few adults to do it. The market turbulence is unlikely to be over soon with leadership like this.  


Friday, June 24, 2016

I woke up…it was a Brexit morning

Clueless is what clueless does… Financial markets and their pollsters got it completely wrong.  The ‘Out’ vote was largely about immigration and dissatisfaction with it and the ‘remain’ faction never ‘got’ that nor tried to combat it. Their tactic was to threaten financial and economic chaos and now they will have to go eyeball to the eyeball with those dire warning statements- which are probably greatly exaggerated. There is message here beyond just the UK…


What’s good for the goose is good for the gander

But what goes around comes around. The U.K. is the United Kingdom not the magic kingdom. And with this vote the U.K, may be posed to get smaller as Scotland is now likely to take a second go at leaving the U.K. What is good for the goose is good for the gander. U.K. claims to Gibraltar are being challenged by Spain, now that the U.K. will be politically OUT of EU. The stage is reset for all sorts of new arrangements to be put in play.


EU to E-MOO or are they cowed?

The EU is telling the U.K. to leave quickly to dispel the air of uncertainty quickly (i.e. don’t let the door hit you in the butt on the way out). And while they will not want to treat the U.K. too well they will not want to treat it too shabbily either. The U.K. is an important trading partner with the rest of Europe and everyone will want to keep that connection. But if the EU makes it too easy and without consequences to leave there could be others to take that route. The U.K. and Denmark got opt out clauses to join the EU and not EMU. For everyone else EU membership is supposed to be the stepping stone to EMU. So how will that work in the future? Can EU set as a membership condition the aspiration to EMU? Does EMU still look that attractive? 



As for geopolitics all European nations went their own way politically although there was also an EU position. The UK will get its full voice back in the international area and they have been a strong U.S. ally. That is a good thing. An ‘independent’ U.K. does not weaken Europe as much as it gives it another independent voice and one-less opinion to bargain with inside EU to craft a single position. 


EU and EMU: now more than ever the Deutsche Zone

The U.K. leaving EU raises the risk that someone else will leave EU…or even EMU. It shifts the balance of power between EU non-EMU members and EMU members who are also EU members. With the U.K. out, the EMU has a huge weight in the EU. The Germans have acted in a way to make EMU membership as unpleasant as possible for everyone else. If there ever was a question about whose culture would prevail in EMU there is no question anymore. Other member countries cannot afford to be out of step with most competitive country in EMU. Germany controls EMU. And Germany’s response to membership has been to run a fiscal budget surplus and run and even lower than 2% inflation rate –stepping up pressure on fellow members in EMU to follow Germany or to slip further behind it.  Germany also has enforced selectively the rules governing the ECB so as to bring maximum pressure on its fellow members. What this does is to make the EMU rule of 2% inflation an upper bound for everyone else particularly after their poor policies in the early days of EMU. Clearly Germany has been a deflationary force in EMU although everyone talks of joining EMU as being growth-enhancing. How about that?





In the wake of Brexit. No one is bankrupt. It is not like Lehman bros. Although sterling has fallen sharply there is no new FX deal to cut. The BOE is independent. There is no need to extract it from the ECB. There are no bailouts to be done. There is no central bank or treasury propping up of anything. In short the U.K’s flexible exchange rate will buffer the economy. A lower sterling will stimulate UK growth. U.K. industry groups have been quick to call for new deal to keep trade flowing Vis a Vis Europe. Europe will be reeling and wonder about further consequences.


The potential Zombie opts out

Questions about London as a financial center may continue for some time. But the EU was flirting with a transactions tax that might have killed London as a financial center anyway had it stayed in. London has bought its freedom form that but at an unknown price. 


Markets gyrate

There are knee jerk reactions in Fx markets and in stock market. But on balance it is in everyone’s interest not to cut off their nose to spite their face. It would make sense that Europe and UK would try to keep commercial ties more or less intact.


It’s’s de-lovely… its decoupling?

The risk here is that there could be more de-coupling. And the act of de-coupling per se is risky. Scotland may leave the U.K. making the U.K a smaller economy and there could be other more painful disassociations in Europe as well. But leaving EMU would be much more painful making that knock-on effect a more remote possibility. Still the U.K. leaving is a shock to the system and it STOPS a move to persistent, mindless, knee-jerk integration.

The globalization hobgoblin

I think a stronger subliminal message here is dissatisfaction with the pressures of various sorts from globalization. For the U.K. immigration was the big risk. But even today commentators are talking about the potential impact on trade and trade-reducing deals.


Broader concerns

LET ME MAKE THIS PERFECTLY CLEAR. Free trade is the best of all worlds. But we don’t live there any more than we live on Mars. This vote is also is a wake-up call to bureaucrats who think they can scare us with flawed analysis and threats. This is a boost to unconventional candidates and to the candidacy of Donald Trump in the U.S. This is another nail in the coffin of analysis by polling. How did that work?


I do not look to SLOW international trade but to reconfigure it. And I believe this vote takes us a step closer to that.


How we got here…

China and the rest of Asia grew through a strategy of export-led growth. That meant they were set to tap into demand in the developing economies and ride piggyback to stronger growth. But as China grew into ‘Baby Huey’ its piggyback ride became piggish. The burden of China’s ride has disrupted growth in the West. China has been able to produce and not consume and there is nothing in economics about having specialized production and consumption countries that leads to a stable result. 


Asia has co-opted the FREE TRADE model in favor of an export-led growth model and that must be changed. But TOO MANY OPINION LEADERS have simply drunk the Kool Aide of any trade instead of insisting on Free Trade.  Asia needs to change to grow (mostly) on the back of tis (own) demand.  U.S. corporations have to invest in the U.S. not just in their offices abroad. And this suggests to me that there is a lot of exchange rate re-alignment that is needed. But China is against it as are a number of Asian and Latin American economies and as are a lot of U.S. corporations who have investments in Asia and intend to benefit from exporting back to the US using cheap Chinese (et al) labor. Like Brexit this will be hard to do and expect the ‘experts’ to be against it.’ It may take an outsider to do it.


Our intelligentsia has done us wrong. And now people may be much less likely to believe its leaders and experts. The way may no longer be shut..


I am not so negative on Brexit. EMU and EU were becoming a straightjacket, run by bureaucrats. What Brexit tells us is that trends can change. Brexit is a breath of fresh air. The U.K. may pay a greater price for it they thought: but at what price freedom? How can the price be too high?      


Brexit morning…

I woke up, it was a Brexit morning

and the first thing that I saw

was the pound falling like a rock

and David Cameron’s fall


news flowed in like butterscotch

and smothered all my senses

pessimism came, it stayed for the day

and it knocked the markets senseless



Now the curtain opens on a portrait of the next day

And the street is paved with passers by

Commerce flies, bureaucrats cry,

But freedom’s come to stay

Won’t you wake up!

It’s a Brexit morning


Tuesday, June 21, 2016

How Fed policy ran amok by focusing on ‘the wrong stuff’

How Fed policy ran amok by focusing on ‘the wrong stuff’
(AKA our ever-changing job market)
The Fed has been making policy with a strong reference to the job market. While we have heard all sorts of criticism about the flaws in GDP, some have acted as though job market data are equivalent to the Holy Grail. Several Fed officials recently have even said quite explicitly that jobs data trump GDP. In what way is that?

All data are subject to revisions of various sorts. And jobs data can be revised and can surprise as they did last month. Apart from that, job data can look friendly and familiar and yet be distant and misleading. With the labor force participation rate so low and the not-in-the-labor-force cohort so large plus myriad demographic changes who can say that we know what these current labor force metrics mean? Can you? The Fed though it could. But it couldn’t.

I am quite serious. Consider the table below: 

This table presents labor market data for the labor force and unemployment rate for those age 25 and up. It provides four exhaustive categories for labor: (1) Less than a high school diploma, (2) high school diploma no college (3) college but less than a BA (4) BA and higher degrees.  Roughly we have unskilled, low-skilled, semi-skilled and highly-skilled categories.

The table shows how the composition of the labor market by those four categories has shifted. When data on these metrics began in 1992, 13% of the labor force was in the lowest skill group. In May of 2016 that proportion is down to 7.6%.  The top-skill, BA-plus category used to comprise 26% of the labor force, now it comprises 38.9% of it. The proportion that is low-skilled is now slightly lower and the semi-skilled group is proportionately higher.

Despite all the job openings that cannot be filled in the JOLTS report, the labor market is much more educated or skilled than it used to be. Still that is not working –apparently there is a skills mismatch. It’s like having enough silverware to set the dinner table for eight but with too many spoons and not enough knives. It doesn’t work. Even if they are the highest quality silver, a spoon is not a knife. 

But, what is still working is that higher education levels are correlated with lower rates of unemployment. If our labor market were of the composition it had been in 1992 the current unemployment rate for all workers age 25 and over would be 4.4% instead of the current 3.9% - one half of one percentage point higher. It appears that our labor market gauge is no longer so easy to read. But it’s good news. It’s like having a gas gauge that is shifted so that the tank is not nearly as empty as the gauge is near ‘E’. You are not as at risk as you think you are to having to walk for more gas...  

The education composition of the labor force has lowered the unemployment rate by one half of one percentage point. And this is only one demographic feature I have isolated. There are other features that are correlated with the rate of unemployment that can be analyzed in this way, among them age, sex, race and more. As we get compositional shifts in these areas either the structural unemployment rates among these various attributes will shift or the impact on the overall unemployment rate will shift or both will shift.

This is why the Fed has seemed so out of step. It has focused on and has been fearful about the rate of unemployment. Just because the rate sort of seems like the same thing it has always been does not mean that its attributes have not changed. The evidence for education is that the unemployment rate is going to look a lot lower just because of who is in the labor force now compared to who is no longer in it. 

As arguments go this one sees the labor force as tilted to more skill and more education. But what it also suggests is that the less skilled and less educated have been squeezed out. We do not have the same data on the attributes of those who are not-in-the-labor–force for example so we can’t really tell.

And, as the minimum wage rises, it is likely that firms will find ways to hire more skilled workers at higher wages possibly using technology solutions to eliminate jobs and become more streamlined and that could result in an even higher skilled labor force.

Try to understand the labor force development as a dynamic process, where supply and demand combine to determine who is in it and who is out. Always bear in mind that compositional characteristics of those NOT in the labor force may be quite different from those who are in the labor force and that might keep those who are on the sidelines on the sidelines.

The table also gives us some notion of how much slack we might have left in this labor market. 

For example since January 1992 the overall unemployment rate has been lower than its May 2016 level 23% of the time and it has fallen an additional 19% from its current level (minimum rate =3.8%) to its low. 

For each of our age cohorts the unemployment rate has been lower: over 20.1% of the time for the lowest skills group, 48.5% of the time for the second lowest skill group, 37.5% of the time for the semi-skilled and 41.0% of the time for the high skill group. Interestingly despite the focus on skills shortages the highly educated group does not have a really low rate of unemployment relative to its own historic standards-especially relative to the other categories- it is in fact the least tight on this metric.

The percentages of time that each cohort’s rate has been lower also echoes the next set of statistics which concern how much farther these cohorts’ unemployment rates can fall to get back to their respective lows (since 1992). The answer is that unskilled unemployment can fall the least, by only 18.3%, and all the other categories can fall in a relatively tight range of from 37.3% to 38.5% further-all about the same order of magnitude. Oddly it is the unemployment rate among the unskilled that is the relative lowest (has the least far to fall to hit its all-time low).

This prompts us to ask why? Are these ‘unskilled’ workers truly scare? Or are they so low-paid that they more easily leave the labor force and become no longer counted as unemployed because government support programs may look more attractive than the low paid wage?

Apply 1992 weights to all the historic data and we find that the lowest age 25 and up unemployment rate allows for a 30.4% fall while the lowest 2016 weigh pattern would foresee a further drop of 32.1%. The 1992 reweighed unemployment rates are lower than their actual May 2016 level 25.2% of the time while the 2016-weighted data have been lower 26.9% of the time. Under the up-to-date weights the unemployment rate can fall by more.

Any way you slice it the new-view of the labor market does not seem quite so tight. There is still some further 30% or more that unemployment rates can fall in order to get back to previous cycle lows looking at a fixed compositional weight for the labor market.

Moreover, we can look at a decomposed Phillips curve over the last three cycles to gain some further insight on what risks we may face in terms of wage repercussions.  

In the chart above we show wage changes (one year % change in Average Hourly Earnings) Vs the unemployment rate for this cycle and for the average of the last two cycles. We present these data by arraying them by lining them up starting with when the unemployment rate first reached 6% in each cycle, possibly creating some wage tension.  We color code the two cycles with unemployment dark blue and wages light blue in the two previous ‘averaged’ cycles and with unemployment dark green and wage light green in the current cycle. What we see is that the unemployment rate has been falling MUCH FASTER in this cycle after it reached 6% compared to the last two cycles. But that at this lower unemployment rate the wage gains in the last cycle would have been much higher at 4% instead of around 2.5%, currently.

Of course there is still evidence here that the Phillips Curve is ‘working.’ The unemployment rate is falling and wages are rising, but the relationship is much diminished. Since the Fed was basing its policy decisions on this relationship the fact that it has been muted had caused Fed policy plans to become overly aggressive.

In short the Fed was simply too worried too soon about the level of the unemployment rate. And we have given several reasons above why this is might be so.

The macroeconomics of the situation has been just too unstable to work. That is an admission that there are too many compositional shifts in the labor force for us to treat all changes in the unemployment rate as equivalent in nature to WHAT THEY HAVE BEEN IN THE PAST.

But there are macroeconomic diagnostics to reveal this too. It’s just that the Fed has scrupulously (unscrupulously?) avoided presenting them.

The Beveridge Curve

What: The Beveridge curve shows a SHIFTED relationship between job openings and the unemployment rate.
Meaning: it now takes MORE job openings to reduce the rate of unemployment
Missed analysis: While everyone has been ‘oohing and aahing’ over the high count of job openings, economists  have missed the fact that it takes more job openings to reduce the rate of unemployment than it used to (and to create a hire). In other words ‘openings’ are worth less than they used to be.
This macroeconomic diagnostic, The Beveridge Curve, has been ignored

Economics usually does not dirty its hands with such things. But because there are so many changes in the economy it is no longer wise to deal in such aggregated data. Yet that is exactly what macroeconomic models do. It is much wiser to decompose the data to see what the macro data really mean in times such as these and not to simply swallow the model forecast hook line and sinker. When we take the time to do that we find that the job market data are really not as reliable as many assumed.

We can make the same points about nonfarm payroll data as we have about the unemployment rate. And those criticisms may be more familiar. Economists (some) have been long complaining of the quantity of low skill jobs being created. We have a service sector economy and it churns out more low low-skill low-paid jobs. Indeed, this is one of the reasons that productivity growth is so poor. Low productivity growth is not an exogenous development. Productivity is low also because investment is low. Investment is low because the US skill pool seems to be lacking some of the more specific skills needed despite the proliferation of highly educated workers. Moreover, the strong dollar makes the US uncompetitive (makes US wages higher in foreign currency terms) and this scares off investment. We have many interrelated problems here. But it comes down to trying to understand the micro-economic foundations of the macro-economic failures. Not all failures will simply reverse themselves. Economies do not necessarily grow out of them into success stories.

The Fed simply does not seem to have spent enough time or effort trying to understand why its pet macroeconomic statistically sophisticated metrics had stopped working. The answer is always that the devil is in the details. It was the same answer this time around.