The unemployment rate’s drop to 7.8 percent, reported last week, marked the first time since 2009 that the rate was below 8 percent. It’s fitting that this occurred shortly after someone who predicted the rate couldn’t get below 8 percent changed his mind.
Until a year ago, president of the Minneapolis Federal Reserve Narayana Kocherlakota had argued that there may be a new normal unemployment rate of 8.7 percent, and that adjusting the rate at which banks borrow money would do little to help. Now he argues that the Fed should commit to keeping rates low until unemployment is declines—a position in line with those hawkish about our unemployment crisis.
Kocherlakota’s arguments were popular among the right, with conservatives like David Brooks name-checking him in his national column. But they also found support from a surprising ally: former President Bill Clinton. Clinton went on David Letterman's show and NPR in 2010, quoting Kocherlakota to argue that we were “coming out of a recession, but job openings are going up twice as fast as new hires” and that “people don’t have the job skills for the jobs that are open.” Even as conservative economists began backing away from this idea, Clinton mentioned it again in his 2012 Democratic National Convention speech, noting that “there are already more than three million jobs open and unfilled in America, mostly because the people who apply for them don’t yet have the required skills to do them.”
The Great Recession has compressed the differences among economists in the Democratic Party, focusing everyone on unemployment. From left-leaning centrists to very liberal economists, they've unified to call for more stimulus to address the jobs situation. But as unemployment gets lower, this united group may fracture. The idea that unemployment is now permanently higher, or couldn’t go to the low levels seen in the late 1990s, could split liberal economists, pulling the rug out from a united front demanding additional measures to boost the economy.
Though it may seem like an optimists’ luxury to contemplate what policy should be if the unemployment rate gets even lower, settling the debate now might help liberal economists take advantage of what we did right the last time the issue came up in the late 1990s.
The question for economists is what the unemployment rate is at full employment. There’s a long, technical name for this with an odd acronym you might hear, NAIRU. If Kocherlakota’s had been right about the current level of unemployment, additional stimulus, whether through the Federal Reserve or through a congressional spending bill, would be counterproductive, only causing increases in inflation. Kocherlakota believed that our unemployment came from the unemployed not being qualified for job openings that are available, and this “structural” unemployment wasn’t a problem of weak demand.
This argument—as well as other conservative arguments, like the idea that unemployment benefits are too generous to motivate people to look for work, or that regulatory uncertainty makes businesses cautious—implodes the moment it is exposed to data. Employers aren’t looking to fill job vacancies that aggressively. Employers are complaining more about weak demand than government regulations. The market is terrible for those with jobs, with weak wage growth and low quit rates. And unemployment is up across the board—across educational levels, locations, occupations, and industries, so this isn’t a matter of some jobs being no longer in demand.
Meanwhile, liberal economists have supported more action to boost the economy. But there are three sets of overlapping arguments that still hinge on the idea that unemployment is now permanently higher after the crash. The first is associated with people like Columbia University economics professor Jeffrey Sachs. Sachs has argued that “America has lost its international competitiveness in basic industries including textiles, apparel, and several other areas of manufacturing.” He attacks “crude Keynesianism” and those who don’t believe in the “severe limitations of short-term fiscal stimulus.” Sachs calls for a “decade of well-designed and well-executed national investments in people, infrastructure, and innovative technologies, in order to boost competitiveness” in the economy. Rather than a temporary downturn in the economy, our unemployment problem is so deep we can’t easily fix it with conventional, Keynesian economic policies.
The second view, often associated with the Obama administration and the numerous deficit-hawk budget commissions, is focused on government debt. In one version, if we take additional steps to boost the short-term economy with more stimulus—especially fiscal stimulus that requires a larger deficit—the financial markets will panic about the national debt. By panicking, they’ll raise interest rates, which will offset any positive effects of the stimulus. In another, the long-term budget challenges the country faces are a serious hurdle , keeping our economy from improving. Many of the major deficit-hawk budget commissions, including Rivlin-Domenici, have stimulus spending in the first years, but that spending is tied to major long-term deficit reduction plans. A cynic might note that it appears that the Very Serious People are holding desperately needed relief for the unemployed hostage in exchange for the latest neoliberal fad on how to dismantle our social-insurance system.
The third issue is that as people are unemployed for longer periods of times, or drop out of the labor force, it will become more difficult for them to find jobs. The technical term for this is called hysteresis, and it isn’t always clear what is the driver here. It could be that the unemployed become despondent, that their skills become outdated, or that employers would always prefer someone who has been unemployed for a shorter period of time. Those worried about hysteresis will often argue that programs like targeted job training are more appropriate than broader efforts to boost the economy.
Tackling long-term problems is important, as is having a budget that reflects the priorities and values that liberals want to fight for. But there’s no credible evidence that these issues are the ones that are impacting the country. Borrowing rates are at all-time lows and, as the economists Brad Delong and Larry Summers have noted, stimulus spending can largely pay for itself when we are away from full employment. And as the labor market tightens, many of the issues with hysteresis will take care of themselves.
President Barack Obama’s administration has used these narratives in discussing the economy. In his 2011 State of the Union speech, Obama argued that in order to “win the future, we’ll need to take on challenges that have been decades in the making,” echoing Sachs’s argument that our problems aren’t weak consumer demand but a massive, generational problem. Obama’s American Jobs Act from fall 2011, which would have provided short-term stimulus and prevented teacher layoffs, was designed to be fully paid for as a result of long-term deficit reduction. This, as all the “Grand Bargain” attempts to get stimulus paired with deficit reduction, leaves it vulnerable to the problem that Republicans aren’t willing to vote to raise taxes.
We've Been Here Before
These approaches assume that the right course of action is to guess the ideal level of unemployment in advance and slow down on economic support and stimulus as the economy approaches it. However, most economists can’t agree on where unemployment should be at full employment, and the complicated labor-market picture doesn’t give them an easier prediction.
Another approach is to get unemployment as low as possible, checking to see if inflation is rapidly increasing. This method presumes that the ideal level of unemployment exists but that we won’t know it until we hit it. This approach is sensible from an empirical point of view, and the last time it was tried, in the late 1990s, was the best period for American workers in over the past 30 years.
As the economics professor Stephanie Kelton noted in a paper analyzing the transcripts of Federal Reserve meetings in the late 1990s, there was a significant fight between those who wanted to pre-emptively hike rates as unemployment went below 5.5 percent and 6 percent, and those who wanted to see how low unemployment could go without triggering other economic problems. One of later members of the Federal Reserve argued that, contrary to people believing that low unemployment alone was a worry, “Neither strong growth alone nor a low unemployment rate alone is a reason to tighten monetary policy.”
Unemployment was less than 5 percent from 1998 to 2000, with an average rate of 4 percent in 2000, and the impact was major for working people. As Dean Baker noted at the time, the domestic economy had an additional trillion dollars relative to a world where the Federal Reserve kept unemployment at 6 percent between 1994 and 2000. Meanwhile, wage growth was strong across the entire spectrum.
Baker also notes that with unemployment so low, and firms so eager to hire workers, many of the supply limitations and hysteresis worries were overcome by employers. “There were accounts in 1998-2000 of companies that were sending buses into inner cities to bring people out to work in hotels and restaurants in the suburbs. There were also accounts of firms providing child care who had not previously, of firms offering flexible hours to accommodate the needs of workers with family care obligations and even firms seeking out workers with disabilities. They wouldn't have done this if the unemployment rate was 7.0 percent and they had a ready supply of workers nearby.”
Full employment is by far the best social program we have. Many of the problems that liberals worry about—from the deficit to the job prospects of those who have been unemployed—are significantly easier to solve when unemployment is as low as it can get. But this can only happen if liberals keep their eye on this goal.