Thursday, February 9, 2017

Claims in uncharted waters; is the labor market too tight?

As the chart above shows, the hallmark of the onset of every modern recession has been a precipitous rise in new unemployment claims, each time from a relatively low level. Unemployment claims as a percent of the number of people working have now reached a new all-time low: only 0.17% of the workforce was laid off last week. Is another recession in the cards? Not necessarily. This statistic has been plumbing new lows for decades, and their is no a priori reason this cannot continue or merely stabilize at current or slightly lower levels.

But there is another cause for concern that is not much talked about. If, for example, Trump and the Republican Congress manage to push through a decent, supply-side tax reform package (e.g., one that at the very least lowers marginal rates for businesses and consumers in exchange for limits on and/or the elimination of many deductions, plus fewer subsidies), where will an expanding economy find more workers? There are precious few to be found among the ranks of those receiving unemployment benefits—fewer than ever before. Meanwhile, the population is growing rather slowly—about 0.8% this year, according to the Census Bureau—and the number of people of working age is growing even more slowly—about 0.6% this year (equivalent to 1.5 million new eligible workers), according to projections by the OECD. At its current sluggish growth pace—about 2% per year—the US economy is on track to add about 2.2 million new jobs this year. Based on just these numbers, it doesn't look like we have enough workers to run a bigger, faster-growing economy.

Don't be surprised if Keynesian economists (which includes many at the Fed) look at these numbers and start worrying about how "tight" the US labor market is, and how faster growth could quickly generate upward wage pressures as businesses compete for scarce workers, and how that in turn could spark higher inflation. Their natural inclination will be to call for higher interest rates to keep the economy from over-heating. It could be like deja vu all over again: over-heating was a phrase we heard quite often in the late 1990s, when the Fed was boosting rates even as inflation was falling. Back then the economy was growing at a heady 4-5% rate and stocks were soaring in the expectation that the good times would continue to roll.

However, I don't want to suggest here that we are going to find ourselves in another 2000-style bubble economy, because there are some very important differences between then and now. Back then real interest rates on TIPS were 4%, PE ratios were on the moon, and commodity prices were collapsing. Today, real interest rates on TIPS are less than 0.5%, PE ratios are only moderately above their long-term average, and commodity prices are rising. Back then the Fed was tightening aggressively, having pushed the real Fed funds rate over 4%, and the Treasury yield curve was flat to inverted—both classic signs of very tight money (see chart above). Today the real Fed funds rate is negative and the yield curve is positively sloped—both signs that money is definitely not tight, nor even close. Monetary conditions today are consistent with an economy that is enjoying a prolonged expansion.

So what is going to happen? How can the economy grow much faster if there aren't enough workers?

One way to thread this needle is to tap the huge number of workers—as many as 10 million, as the charts above suggest—who have left the workforce. Lower corporate income tax rates and reduced regulatory burdens would create new incentives for businesses to expand, and cutting marginal income tax rates would create new incentives for people to rejoin the labor force, by offering them more wage bang for their work buck. Let people keep more of what they make and they will likely be more willing to work more, or go back to work.

A dose of supply-side stimulus, in other words, should result in more jobs and more workers willing to fill those jobs. It needn't result in higher inflation.

If inflation becomes a problem in the years to come, it won't be because the economy is growing at a faster pace. It will be because a faster-growing economy goes hand in hand with increasing confidence, and increasing confidence will likely reduce the public's demand to hold the huge cash reserves that have been stockpiled in recent years (see chart above), and it will be because the Fed fails to take the steps necessary to offset declining money demand by shrinking the supply of excess reserves and/or raising interest rates by enough to maintain the banks' willingness to hold those excess reserves. In the end, inflation is a monetary phenomenon, not a by-product of faster growth. The Fed holds the key to inflation. A successful batch of supply-side, Trumpian policies holds the key to faster growth.


Benjamin Cole said...

A fascinating post at a fascinating time.

I take minor issue phrases such as "labor shortage" or "not enough workers." There is only supply and demand, and where the lines cross.

Even at the Super Bowl, where seats cost up to $15,000, and the supply of seats is fixed, economists do not to say there was a "Super Bowl seating shortage."

(BTW, people who paid for their seats at the SB actually got their money's worth this year--that was a game, no?)

Add on, the Phillips Curve is dead and buried. We see in the US periods of rising employment with steady prices or even disinflation since the 1990s. In fact, the 35-year trend for inflation and interest rates is down.

Add on, add on: In Japan the unemployment rate is 3.1%, and they have deflation. Thailand has no unemployment and no inflation.

There are millions and perhaps tens of millions of Americans that could be lured back into the workforce, probably by higher wages.

I would like to see lower taxes on employment income, and reforms in government social welfare programs to encourage working (including the VA--really a full pension and complete medical coverage after 20 years of employment? A 45-year-old guy who retires and becomes unproductive?)

I hope the GOP, Trump and the Fed let it rip.

I would like to see Full Tilt Boogie Boom Times in Fat City for a many years.

All this handwriting about 2% inflation or free trade is besides the point. Trump has many flaws, but I think he has the right attitude about economic growth. Let it rip, dudes!

The US does need the Supreme Court to say property zoning is unConstitutional.

Property zoning is probably the largest structural impediment to growth along the West Coast.

steve said...

Amazing that wages are still relatively stagnant given the ostensible tightness in labor markets. One has to wonder IF the labor markets are as tight as numbers suggest given lack of wage growth.

Matthew Grech said...

Sign me up for Full Tilt Boogie Boom Times in Fat City. I love that phrase. You should trademark it or something, Benjamin. I'd buy a t-shirt if you make 'em.

I think Trump has the right attitude about economic growth, too. But I am waiting to see that viewpoint confirmed when he comes out with his "tremendous" tax plan. If border adjustment is in it, I will be furious.

Benjamin, I 100% agree with your opinion on property zoning, especially along the West Coast. (I'm from the NorCal coast.) But, like social security or Pentagon waste, I've come to accept that it'll never change.

Scott Grannis said...

The more I see about the so-called Border Adjusted Tax the more I think it will never fly. It's very controversial and would have disparate impacts on a number of industries, primarily those that import a lot but do not export much. There is too much dissension among the ranks of economists for this to fly, not to mention the problems that some companies would face having to adjust to brand-new rules of the game.

Benjamin Cole said...


Yes, my railing against property zoning is futile. Everyone is a pinko-socialist when it comes to property zoning in their own neighborhood. And more than 50% of commercial bank assets are extended on property. Our financial system does not want unzoned property.

On the border tax: Not sure. Other nations have a version, called a VAT tax.

Yes, yes, I am aware of all the arguments that a VAT tax is not a border tax, but in fact it is applied at the border on imports.

BTW, chronic national trade deficits may not be all roses. See

Chronic trade deficits=property price explosions.

I am holding my nose and hoping for the best from Trump.

Frozen in the North said...

Dear CBP

Sure there was a huge gap between those who had left the labor force because there were no jobs around, but this is no longer the case. I suspect that the tax cuts will not do very much, because I would assume, maybe wrongly, that deduction will fall sharply. The headline corporate tax rate in the US is around 35%, but the actual tax payment is around 17%. The difference are deductions. My guess is that the uncertainty on what deduction remains will slow investments.

Moreover, the FEDS are about to tighten as the economy has little slack. finally, the US population is no longer growing at 1.2% per annum. The figure now is around 0.8% and the labor force is growing by 0.6%, about half of the historical average. This is caused by end of the baby boomer period and other demographic changes.

Aside from the White House everyone agrees that the fundamental change to labor force participation rates is not 'discouraged labor force" rather its shifting demographics.

On the bright side the US is in better position than Japan and Italy

Scott Grannis said...

When tax rates are high, taxpayers have a strong incentive to maximize the use of deductions, minimize the realization of gains, and minimize and/or postpone income. The extremely high corporate tax rate has resulted in some $3 trillion of corporate profits accumulating offshore, where it sits waiting for tax rates to fall. Corporations are effectively minimizing their income and maximizing their use of deductions in order to pay a lower effective tax rate.

If tax rates fall because deductions are sharply curtailed and/or eliminated, corporations would be much more inclined to increase their realizations of gains and to repatriated offshore profits. The U.S. currently is being very stupid, attempting to charge 35% of overseas profits, when all that happens is that those profits are not declared or repatriated. A high tax rate has resulted in a dramatic reduction in the effective tax base; the IRS collects 0% of $3 trillion. If the rate were lowered to 10% or 15%, repatriations would soar and tax revenues would soar.

When analyzing the effect of tax rates and deductions, the most important is the maximum or highest tax rate, since that is what influences decisions on the margin. In my own case, for example, my marginal tax rate, should I return to work, is currently 65%. I refuse to work if I can only keep one third of what I make. So I don't work and the government gets no extra money. Deductions don't figure in; this is the rate I would pay on $1 of additional income. If my marginal rate were to decline to, say, 25%, I would be much more likely to work or to start a business, or maybe even seek to earn some advertising income from this blog, even if all my deductions were eliminated.

A rational taxpayer should always choose fewer deductions in exchange for a lower marginal tax rate. Homeowners should pray for the elimination of the mortgage interest deduction if instead they could have a lower rate on their incomes. Why? Because a rational person expects to earn more in the future, and having that money taxed at a lower rate would more than make up for the loss of a fixed amount of mortgage interest, at least for most people.

I am aware that demographics can explain a large part of the decline in the participation rate. But I would argue that some non-insignificant number of baby boomers that have left the workforce, such as myself, would opt to re-enter if marginal tax rates were cut meaningfully. Tax rates have a big influence of people's decisions, believe it or not.

Frozen in the North said...


As they say, in a perfect world you are absolutely correct. Except uncertainty is a real issue. As an example, lets say that as a reduction in corporate taxes, the giveaway is a cancellation of the deduction of health care coverage (I know I know), but its a big chunk of cash for companies anyway.

That changes the dynamic since the employees are now more the US (see where we could go with this argument)

The problem with remodeling the tax system (and its not like you can cut tax rates and leave all the deduction (I could be wrong there), but timing and certainty are everything.

BTW I agree entirely with you assessment. The real question is what's the tipping point -- where lower taxes create incentives to invest (as opposed to ay massive dividends -- which is not investment). For what its worth the $3 trillion is not really parked offshore, its has been used as collateral (except Apple and Google) for domestic loans -- the unwinding will simply lead to a reduction of loans outstanding against cash.

minnesota nice said...

Excellent post and comments. You put me in a quandary, however:
Am I willing to endure advertising on my favorite blog in exchange for a growing economy and rising asset prices?
I may have to rethink my marginal utility of tax cuts.