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In August, nonfarm payrolls posted their smallest decline in a year. These days, that qualifies as “good news.” It’s a sharp contrast to the dramatic job losses we were seeing in the first half of the year. The unemployment rate headed higher. While there were no special factors behind that increase, we should note that there is a fair amount of statistical noise in the monthly household survey data. Still, it’s been widely expected that labor market conditions would remain weak through the early part of the recovery. What’s likely to happen as we work through 2010 is very much uncertain.
Nonfarm payrolls fell by “only” 216,000 in August. That’s still very high, but it’s nowhere near as horrible as what we were seeing earlier this year. Job losses remained widespread across industries in August. Budget strains are leading to job losses in state and local government payrolls, which normally hold up well in recessions. These budget strains will offset some of the positive impact from the federal fiscal stimulus package. The stimulus bill did include some federal aid for the states, but it’s not been enough.
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The unemployment rate rose to 9.7% in August. Many were excited about the reported drop in the unemployment rate in July, but that decline was only due to a drop in labor force participation (which declined in both June and July). The employment/population ratio fell to 59.2% in August, the lowest in a generation (this ratio also suggests that we never fully recovered from the last recession). The unemployment rate is expected to move a bit above 10% through the end of this year.
Average hourly earnings rose 0.3% in August. The minimum wage rose for the third consecutive year in July, but appears to have had little impact on average earnings (which are still far above the minimum wage).
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There’s some pent-up demand built up in recessions, as households postpone big-ticket purchases. We’re seeing some evidence of this in the improvement in home sales and autos, but tight credit and a weak labor market remain significant restraints on consumer spending. More worrisome, despite good second quarter numbers, the underlying trend in productivity growth appears to have slowed. If this continues, the upside prospects for growth will remain somewhat limited.
Recent economic data have suggested that the economy may have bottomed. That doesn’t mean that everything is wonderful. There are serious headwinds, mostly in the form of financial strains and tight credit. Yet, there is ongoing support from monetary policy, and fiscal stimulus is beginning to pick up. The prospects for a near-term double dip, assuming that we are coming out of the first dip, seem small. The bigger concern will likely be in 2011. It will take a steady hand at the helm.
Aggregate wage and salary income fell 5.1% in the 12 months ending July, down 7.0% in the private sector. That’s a serious hit to the consumer spending outlook and it’s natural for many investors to despair that we’ll never recovery. However, wage income falls in every major recession, and the economy does eventually recovery. The automatic stabilizers (tax payments fall in recessions, while transfer payments increase) have helped soften the impact of falling wage income. Personal tax payments fell 19.9% y/y in July, while transfer payments rose 13.5% (unemployment insurance benefits nearly tripled, up 189.3%). Disposable income was down only 0.3% y/y in July – and thanks to lower oil prices, it rose 0.6% y/y after adjusting for inflation.
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Still, while the downside impact of a weak labor market has been softened, it hasn’t been eliminated – and a sustainable recovery will depend on job growth. The job market often lags in a recovery. However, at this point, we must begin to see a further reduction in the pace of job destruction. Many firms responded to the panic of the fall of 2008, by slashing payrolls and cutting back on capital expenditures. These moves, in turn, have helped shore up corporate profits, which sets the stage for broader economic improvement.
Consumer spending, adjusted for inflation, fell in March and April, but improved in June and July. The “Cash for Clunkers” program boosted motor vehicle sales in August. Some of that may be a cannibalization of future sales. However, there is normally some pent-up demand built up in recessions as consumers postpone big-ticket purchases. In addition, the program may have helped shift consumer attitudes. The recent data suggest that consumer spending (70% of overall GDP) is likely to post positive growth for 3Q09.
Two other factors will add to growth in the current quarter and beyond. Revised 2Q09 GDP figures showed an even steeper decline in inventories through June. Inventories still appear to be a bit high relative to the overall pace of sales, suggesting that the inventory correction has yet to run its course. However, inventories do not have to rise to add to GDP growth. They only have to fall at a slower rate – and that is certain at some point. Increases in final demand will eventually lead to increases in inventories, but that may still be a few quarters away.
The fiscal stimulus package will also support growth in the next several quarters. About 10% of the fiscal stimulus had gone out through mid-August. Half will show up in FY10 (which starts in October).
The danger of a double dip is further out. A common mistake in past major recessions, both here and abroad, has been to take away policy stimulus too early. Both Fed Chairman Bernanke and Chair of the President’s Council of Economic Advisors Christina Romer are experts on the Great Depression and each is well aware of the danger of reducing stimulus too soon.
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There’s little danger of inflation in the near term. Measures of core inflation have been trending down. The Fed has a lot of time before it will have to hike rates. The fiscal stimulus will start to decrease into 2011 and become a restraint on GDP growth. Ideally, the private-sector economy will be growing more strongly by then.
This week, the Office of Management and Budget and the Congressional Budget Office will release revised budget projections. It’s been leaked that the OMB’s estimate will fall from $1.84 trillion (yes, that’s “trillion” with a “t”) to $1.58 trillion. That’s still a lot of borrowing. The increase in government borrowing will cause long-term treasury yields to rise right? Well, no actually…
Recall from Econ 101 that:
Y = C + I + G + (X – M)
Or output (Y) is consumer spending (C) plus business investment (I, not the same as financial investment), government consumption and investment (G), and net exports (exports, X, minus imports, M). Also recall that output is also equal to income:
Y = C + S + T
That is, income is either consumed, saved, or taxed. Subtracting the second equation from the first and doing a little algebra yields:
(M – X) = (I – S) + (G – T)
The trade deficit equals the shortfall in domestic savings (private investment less private savings) plus the budget deficit. Simply put, if we don’t save enough to fund business investment and balance the budget, we need to rely on foreign capital inflows (which happens to be the mirror image of the trade deficit).
Consider where we are now. The trade deficit has decreased and the budget deficit is higher. Therefore, the investment/savings shortfall must have decreased. Private savings has increased and business investment has fallen. In other words, the excess supply of credit (savings minus investment) has risen more than the increase in the budget deficit, and all else equal, interest rates should be lower. As with any recession, the increase in government debt happens exactly as the demand for safe assets increases.
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The increase in government borrowing has been offset by a decrease in private-sector borrowing.
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Do long-term interest rates depend on the demand and supply of money (monetary policy) or on the supply and demand for savings? J.R. Hicks showed us (several decades ago) that it depends on both.
Additionally, long-term interest rates can be thought of as a series of short-term interest rates. An expectation of the future path of short-term interest rates is embedded in the long-term rate (that doesn’t mean it’s a fool-proof predictor). The slope of the yield curve is perhaps the single best leading economic indicator. That slope is currently high, consistent with an improving economic outlook. Long-term interest rates normally rise as the economy recovers, but as we’ve seen recently, they should not rise too rapidly as they would threaten the recovery. Long-term rates are higher than they were at the start of the year, but that reflects the unwinding of the flight-to-safety (the economic outlook was much more worrisome earlier this year.
Still, while the increase in government borrowing is not a problem in the near term, investors are naturally worried about whether large budget deficits will persist. They won’t. This year’s startling increase in the budget deficit is the result of cyclical factors (tax revenues fall in a recession, but rebound as the economy recovers) and temporary spending (the financial rescue, the fiscal stimulus). The deficit will decline as the economy recovers and temporary spending programs fade away. Still, there is a structural deficit to deal with. Even after the economy recovers, the government will still spend more than it takes in, and strains will increase as the baby-boom generation retires (note that a main goal of healthcare reform, according to White House officials, is to reduce inflation in healthcare costs, including Medicare). Deficit reduction may require higher taxes, but only after the recovery is well entrenched.
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