Here’s a couple anecdotes I’ve heard about unemployment insurance:

1.  A couple years ago a commenter mentioned the following story from someone who ran a hotel in California.  A dozen or so maids were laid off during the recession.  After a few months the owner tried to hire them back.  They declined, saying that with their husband’s income and their unemployment insurance checks they found they didn’t need the second income.  But note; if they were collecting UI then they would be required to call themselves “unemployed.”

2.  A few days ago an acquaintance mentioned that he heard the following story from a Chicago taxi driver.  He said it was hard to keep drivers, because they’d work for a few months and then go collect UI.

How are we to react to stories like these?  Are they apocryphal?  After all, you can’t collect UI if you quit your job.  Except you can, I’ve known people who did so.  Are they not politically correct?  Do they represent “blaming the victim?”  (Something I’ve been doing a lot recently.)

OK, here’s my complaint.  I don’t like the way progressive bloggers talk about this issue, for all sorts of reasons (which have nothing to do with ideology–I’m not hostile to their policy views.)  There’s a suggestion that anyone who talks about the disincentive effects of UI is somehow either clueless or cold-hearted.  Maybe that’s true of some, but there are all sorts of reasons to take this issue very seriously.  And suggesting UI has effects on employment is not the same thing as calling unemployed people “lazy.”  Consider the following:

1.  The statistical evidence on UI is overwhelming significant.  When the UI benefits maxed out at 26 weeks, there was a spike in the number re-employed right after the benefits ran out.  That’s not to say the benefits are necessarily inefficient, if the spike was due to the income effect then UI might actually make the job market more efficient.  But it’s hard to dispute the fact that UI insurance does have some effect on labor supply.  And that means some effect on employment, as studies show that the effects on unemployment duration even occur in areas with double digit unemployment.

2.  Many Western European countries such as France saw their natural rates of unemployment rise from around 2% in the 1960s to about 10% in the 1980s.  We don’t know all the reasons, but the most plausible explanations have to do with various labor market policies.  Progressives have NEVER come up with a plausible explanation for this sharp rise in the European natural rate of unemployment.  Until they do they have no business calling out conservatives who warn that the same thing could happen here.

3.  Denmark recently found that their four year maximum on UI benefits was distorting the labor market, and cut the maximum duration to 2 years.  Denmark is arguably the most progressive, most civic-minded country on Earth.  Were they just imagining this problem?  Were the policymakers over there hypnotized by Casey Mulligan?

4.  Both liberals and conservatives seem prejudiced against the proletariat, but in slightly different ways.  Some conservatives seem to think the unemployed are lazy, not willing to work hard.  This outrages liberals, but I find their defense of the unemployed to be just as offensive.  They seem to concede that if UI did increase unemployment, then the accusation of “laziness” would be valid.  That’s easy to say if you have a nice, cushy, interesting white collar job that pays well.

I used to do various construction jobs like painting and roofing.  It’s work I can do.  Suppose I lost my six figure job and was offered a job paying $20,000 a year doing roofing.  Would I take it?  No, I’m too “lazy.”  I’d keep collecting those UI checks and keep looking.  Now consider those lucky hotel maids that were offered jobs paying something like $20,000 for the privilege of cleaning toilets and watching naked IMF chiefs parade around.  And let’s assume they didn’t need the money because their husband had a job and they were also getting UI checks.  And maybe they had kids they wanted to spend time with.  How’s their decision any different from mine?  Don’t we all follow self-interest?  How does all this moralizing advance the positive issue of how many people are unemployed due to the 99 week UI maximum.

I don’t think anyone claims it’s the reason for all unemployment—large numbers of unemployed don’t even collect UI insurance.  My guess is that around 1 out of every 100 Americans are current unemployed due to extended UI and higher minimum wage rates.   Casey Mulligan seems to think it’s 2 or 3 out of 100.  I think that’s too high, that AD is still a big problem.  But we ought to be able to have a civil debate without descending into personal attacks.  It’s an empirical question, and until we understand it that way we won’t be able to make sensible policy judgments.  My hunch is that the Danes have already reached this understanding.

Now for a curve ball.  I’m not calling for less UI right now.  I’d like to see more monetary stimulus, and then gradually reduce the maximum UI benefits as jobs become more available.  So I have “progressive” views on the AD question.  But just because AD matters doesn’t mean AS stops mattering, no matter what the new-old Keynesian models tell us, and no matter how squeamish we are about talking about the issue.

In the long run we should reform UI to give workers more “skin in the game” (and idea progressives seem to hate.)  If it’s going to worsen inequality, then accompany it with actions that make the payroll tax more progressive.

PS.  I plan to visit the university where Krugman/Bernanke/Svensson/Woodford currently teach or once taught.  I may not be able to approve or respond to comments for a few days.

Becky Hargrove sent me this recent article about Bernanke:

The Fed, he said, believes inflation will remain near the central bank’s target of 2% or a little less. The economy can support an unemployment rate around 5% to 6% without fueling inflation, he added.

“I do believe we will return to a healthier growth rate. I don’t see any reason why we couldn’t,” he said.

It’s good to hear that Bernanke thinks the problem is demand side, not structural.  Oddly, I actually think it’s more structural than he does.  If we stay at 99 week maximum UI benefits, I’d expected the natural rate to be in the 6% to 7% range, especially if the minimum wage rate stays this high.

So Bernanke thinks easier money would help the economy even more than I think easier money would help the economy.  But he fails to see one very obvious potential problem.  There is something that could prevent a return to “healthier growth.”

Let’s assume inflation stays near at 2%.  And let’s also assume that they allow NGDP to grow at a bit over 4%.  Then we won’t get a “healthier” recovery.

But why would I make such a pessimistic forecast about NGDP growth?  Why expect it to be so low?

Umm, maybe because it’s been low for the past several years.

Maybe because private forecasters expect it to remain low.

And maybe because the bond market seems to expect low NGDP growth (as far as we can tell.)

Other than those three reasons, there’s no reason at all that the economy can’t have a healthier recovery with 2% inflation.

And who determines the rate of NGDP growth?  There’s probably an answer somewhere in Bernanke’s intermediate macro textbook.

Here’s a story on found on Tyler Cowen’s blog:

They are a cornerstone of Chrysler’s unlikely comeback: 900 employees turning out a Jeep Grand Cherokee sport utility vehicle every 48 seconds of the working day at an assembly plant here.

Nothing distinguishes them from other workers at the Jefferson North plant, except their paychecks. The newest workers earn about $14 an hour; longtime employees earn double that.

…the advent of a two-tier wage system in Detroit is spiking employment for one of the country’s most important manufacturing industries.

Here’s what we know for certain about the US business cycle:

1.  If nominal wages are highly sticky, then NGDP slowdowns will raise unemployment.

2.  Nominal wages are highly sticky for at least some workers.

3.  The period after mid-2008 saw the largest NGDP growth collapse since the Great Depression.

4.  The period after mid-2008 saw a huge rise in unemployment.

Here’s what we don’t know:

1.  Why didn’t Chrysler cut all wages to $14?  Fear of strikes?  Efficiency wages?

BTW, I do realize that long time employees are more skilled on average.  But that sort of huge pay gap didn’t exist in the 1960s or 1970s, and thus I think we can assume at least a big part of it is “artificial” in some sense.

Marxists would argue that further pay cuts for infra-marginal workers would merely raise profits.  I believe some of the money would go to extra employees.  And as Nick Rowe showed, in the public sector all of it could go to additional jobs.  I’d also note that health care is practically the public sector.

In an earlier post Tyler Cowen asks this question:

1. For how long “” in today’s America “” can an AD-driven recession last?  At what point do even the Keynesians toss in the towel and say “By now it is a growth and structural problem, not mainly AD”?  After all, the private sector had a chance to create more M2 and it failed.  How sharp is the distinction between the short run and long run?

Great question.  If I were forced to argue against my theory of the recession in an Oxford debate, my top three arguments would be:

1.  Natural rate hypothesis.

2.  Natural rate hypothesis.

3.  Natural rate hypothesis.

It’s a great model, I believe in it, and it suggests nominal shocks shouldn’t last for more than a few years.  I’ve already argued for the “entanglement theory” of this recession (between structural and AD factors), but let me provide three reasons why I think that monetary stimulus would help three years after the 2008 crash, but would not have helped (much) three years after the mid-1981 collapse in NGDP growth:

1.  The problem of 99 week extended UI benefits.  Powerful monetary stimulus would lead to a quick repeal.

2.  The problem of money illusion.  It’s much easier to slow the rate of increase in nominal wages, than to cut wages outright.  In 1982 we needed to slow the rate of increase in wages.  Now we need to actually cut many wages, which is far harder even if the consequences for real wages are exactly the same.  After I made this comment in a previous post lots of commenters wrote in trying to provide a rational explanation for worker reluctance to accept nominal wage cuts.  I thought all their arguments were bogus, and it just confirmed my view that money illusion exists.  My commenters are really smart.  If even they have money illusion I think it’s safe to assume the broader public does as well.

3.  The problem of reallocation out of fields like housing.  More NGDP would reduce the debt burden and raise real housing prices.  This would reduce unemployment caused by construction workers having a hard time finding other jobs.  Of course I’ve argued that housing is not the main problem with the recession, but it is a problem.

None of these applied to the 1983-84 recovery, which was the best example of the natural rate in action.  The UI wasn’t raised from 26 to 99 weeks, there was higher trend inflation, and hence less need to cut nominal wages, and there was no big housing/debt crisis.  Even the minimum wage situation was slightly different.

I would take Tyler Cowen’s challenge, and direct it at Keynesian fiscal policy advocates.  Originally fiscal policy was justified on the basis that NGDP was growing slower than Ben wanted, but Ben would not fix the problem on his own.  On the other hand, he wouldn’t stop fiscal stimulus from fixing it.  I never quite bought the argument, although I find it defensible.  But for how long?  After all, it is a fairly convoluted way of looking at monetary policy, isn’t it?  Is it still true?  Is monetary policy still not reacting at all to NGDP growth trends?

PS.  I don’t follow Tyler’s M2 comment.  I think he means NGDP.  But the private sector can’t create NGDP, only the Fed can.  And they haven’t created enough to support many jobs without massive wage cuts.  And it’s hard to cut wages, as we’ve seen at Chrysler.

Here’s a passage from a recent AER paper by Pierpaolo Benigno and Luca Antonio Ricci:

This paper offers a theoretical foundation for the long-run Phillips curve, by introducing downward nominal wage rigidities in a DSGE model with forward-looking agents and flexible-goods prices, in the presence of both idiosyncratic and aggregate shocks. .  .  .

Several important implications arise. First, the optimal inflation rate may not be zero, but positive, as inflation helps the intratemporal and intertemporal relative price adjustments, especially in countries with substantial macroeconomic volatility or low productivity growth. Second, the ideal inflation rate could differ across countries (and in particular it would be higher in countries with larger macroeconomic volatility and lower productivity growth), and may change over time. Third, stabilization policies can play a crucial role, as they can improve the inflation-output trade-off.

Additional theoretical implications arise. First, the overall degree of wage rigidity is endogenously stronger at low inflation rates and disappears at high inflation rates, unlike in time-dependent models of price rigidities where prices remain sticky even in a high-inflation environment. This arises from the endogenous tendency for upward wage rigidities (as in Elsby 2009), resulting from forwardlooking agents anticipating the effect of downward rigidities on their future employment opportunities. Second, this endogenous wage rigidity also introduces a trade-off between the volatility of the output gap and the volatility of inflation, as at low inflation adjustments occur mainly via changes in output and at high inflation via changes in wages. Third, the Phillips curve may arise not only from the need for intratemporal relative price adjustments across sectors in the presence of downward rigidities (as in the traditional view), but also from the need for intertemporal relative price adjustments, which open the way for the important role of macroeconomic stabilization policies discussed above. Fourth, nominal shocks can have high persistent real effects, suggesting that introducing downward wage inflexibility in a menu-cost model à la Golosov and Lucas (2007) would likely change their conclusion that nominal shocks have only transient effects on real activity at any level of inflation.

So there are models that predict persistent output gaps as a result of downward nominal wage rigidity, especially near zero inflation.  And remember we have conclusive evidence that nominal wages do exhibit downward rigidity, especially near zero inflation.

In the same issue of the AER, Peter Diamond has some interesting comments on the structural/demand-side debate:

Second, for the current moment, the argument about the aggregate demand side is academic, in the negative sense of the word. Current estimates I have seen of how much of the increase in unemployment from a few years ago is “structural,” rather than due to inadequate aggregate demand, still leaves enough need for aggregate demand stimulation that it is clear what direction is needed for further policies.

Third, I am skeptical of the value of attempting to separate cyclical from structural unemployment over a business cycle. When firms evaluate candidates for positions, they consider the quality of the match of available candidates, projections of the availability of new candidates, and the value to the firm of filling the slot. That is, the willingness to hire for a given quality of match depends on expectations about the profitability of investing in a new worker and about the likely pool of future applicants.

The tighter the labor market and the more valuable the filling of a vacancy, the more a firm is willing to hire a worker who is a less good match and who may need more training. In other words, a worker who might be viewed as structurally unemployed, as facing serious mismatch in the current state of the economy, may be readily employable in a tight labor market. The common practice of thinking about the extent of unemployment as a sum of frictional, structural, and cyclical parts misses the point that the tightness of the labor market affects worker quitting decisions and affects employers’ willingness to hire an applicant who needs more training. In so far as direct measures of frictional or structural unemployment are dependent on the tightness of the labor market, they have limited relevance for the design of demand stimulation policies. The idea that the US economy is not adaptable and capable of dealing with the need for skills and jobs to adapt to each other is peculiar, given the long history of unemployment going up and down.

Those are two themes I’ve emphasized.  Structural and demand-side problems are deeply entangled, indeed I think the problem is even worse than Diamond does–as he puts little weight on the UI benefit extension to 99 weeks.  And second, even if we have major structural problems, there is still a clear need for demand stimulus.

No, that’s not a typo.  And yes, I am good at math.  In this post I’ll try to reconcile two very different perspectives, each of which seems quite plausible:

1.  The problem is obviously aggregate demand.  In 2009 NGDP fell at the fastest rate since 1938.  The recession is closely correlated with that decline, and both theory and history suggests that such a decline is always bad for growth.  Financial markets respond to rumors of monetary easing in a way that suggests they believe it affects real growth.  Countries with more expansionary monetary policies tended to do better, at least in most cases.  (Australia, Poland, and Sweden, but not Britain.)  David Glasner showed that stocks and TIPS spreads are correlated during this recession, but not before.  Paul Krugman has a recent post showing that wages are obviously very sticky at low inflation.  We clearly have an AD problem.

2.  The problem is obviously structural.  Youth and unskilled unemployment is particularly high, presumably partly due to the 40% jump in minimum wages.  When European countries introduced policies like two year UI, their natural rate increased.  Now we’ve done the same.  Manufacturing firms report a shortage of skilled labor.  Nominal wage growth rates and core inflation have stopped falling, suggesting that wages and prices have reached some sort of equilibrium.  There’s an immigration crackdown.  There is rapid growth in occupational licensing laws, making it much more difficult to become self-employed.

Previously I’ve suggested that supply and demand shortfalls might become entangled.  Today I’d like to briefly summarize why, and discuss the implications.

1.  Why do demand shortfalls worsen AS?   I can see several possible reasons.  The nearly 10% drop in NGDP relative to the path expected when minimum wages increases were enacted, has effectively raised the real minimum wage by 10% more than intended.  (Wages should be deflated by NGDP, not prices.)  The demand shortfall caused Congress to extend UI benefits from 26 weeks to 99 weeks.  Since workers suffer from money illusion near 0%, the supply-side may deteriorate when nominal wage cuts are needed.  If public sector wages are sticky, it may place a burden on the private sector.  If the recession leads to big deficits (as ours has) it may lead to expectations of higher future taxes.

2.  Why do structural problems worsen the demand shortfall?  Two possible reasons (only one of which supports fiscal stimulus.)  If the Fed targets interest rates, or is passive at the zero bound, then a falling equilibrium natural rate may unintentionally tighten monetary policy.  Obviously the Fed also cares about things like inflation; otherwise the price level would be indeterminate.  But in the short run (with interest rate targeting) an adverse supply shock could reduce AD, just as fiscal stimulus could raise it.  The other problem is inflation.  Structural problems reduce AS, and raise inflation. If the Fed is targeting inflation, that causes them to do less monetary stimulus.  This channel works against fiscal stimulus.

So far everything seems symmetrical.  But I do think there is an important difference.  In my view monetary policy can solve 100% of the AD problem, but policy reforms can only solve a modest portion of the AS problem.  If we cut the minimum wage back to $5.15, and cut UI back to 26 weeks, it might cut one point off the unemployment rate, say from 9% to 8% (assuming 5% is the natural rate during normal times.)  Other structural problems are harder to address.  On the other hand if the problem is 75% AD, then monetary stimulus alone could cut unemployment from 9% to 6%.  That’s partly because it would reduce the real minimum wage, partly because it would cause Congress to end the 99 week UI program, and partly because it cuts real public sector wages, and partly because it reduces the problem of money illusion at 0%.  (Here I assume that the natural rate went up by 1% (from 5% to 6%) because of other structural problems such as labor re-allocation, which the Fed can do nothing about.)

So even if the problem is both 75% AD, and 75% structural, policymakers should be much more focused on the AD problem, at least in terms of the recovery.  Obviously structural changes like tax reform and better regulation will produce greater long run gains than any demand-side policy.  But we shouldn’t kid ourselves that those can solve the demand shortfall problem.

Deep down even conservatives must understand this.  If a Reaganite was president and doing aggressive supply-side policies, you can be sure the WSJ would be demanding easier money to help facilitate growth, just as they asked for easier money when Reagan himself was president and inflation was 4%.  Recent conservative hysteria about inflation is completely at odds with their relative silence during the Bush years, when inflation was higher than under Obama, and the dollar plummeted in value (it’s been fairly stable under Obama.)