Economic Growth Yet to Hit Job Market – washingtonpost.com

In AP and IB Economics, we understand the importance of macroeconomics to policymakers, whose primary macroeconomic goal is growth. Economic Growth, defined as an increase in a nation’s total output of goods and service (and therefore the national income), is desidred not only for the sake of growth itself (producing more stuff requires more resources, and may not necessarily make the average citizen better off), rather growth is needed in order to achieve full-employment of a nation’s labor force.

Growth is good. This tenet of economics is rooted in two basic observations: 1. Growth leads to an improvement in the average standard living of a nation’s people, and 2. Growth is needed to employ the growing workforce of a nation experiencing population growth and immigration.

America’s work force is a diverse group of people of all skill levels. 150 million strong, the nation’s workforce requires a healthy national economy with strong investment and consumption to maintain enough jobs to keep unemployment low.   In the last two years, however, the prospect of employment in America has diminished as the number of people out of work has grown to nearly 15 million.

Involuntary unemployment is perhaps the most serious cost of an economic slowdown. A willing and able worker (or 15 million of them!), skilled in mind and body, unable to find prouductive work, represents a monumental failure of a nation’s economy. Policies aimed at promoting growth are in fact aimed at creating employment.

The costs of unemployment affect not only the unlucky  individuals who have have lost their job. Social costs include increased crime and poverty, psychological costs include stress, anxiety, loss of self-image and depression. The economic costs are myriad. Unemployed workers become dependent on the rest of society for support, in one way or another. Benefits for the unemployed payed by the government require greater budget deficits or increased tax burden on the employed. The large pool of jobless citizens seeking work puts downward pressure on the wages of those still working, as employers find it difficult to keep paying high wages while demand for their products has fallen and millions of job seekers are willing to work for less.

The families and friends to whom unemployed workers turn for help find their already stretched incomes spread even thinner. Without steady incomes, the unemployed consume less, putting further strain on an already depressed economy. Deflation can result from unemployment, which can lead to futher layoffs by pessimistic firms, excacerbating the situation and plunging the economy into what’s known as a deflationary spiral.

For all the reasons above, policymakers strive to promote growth. When monetary policy fails to incite spending, the government must pick up the slack, hence the stimulus package so discussed in America today. China’s stimulus of over $500 billion (twice that of the US, as a percentage of its GDP) has had a positive effect on both GDP and the job market.

Employment levels in China began to recover over the past three months in the latest evidence of the rapid rebound in the economy from the international financial crisis as a result of heavy public investment.

Yin Weimin, China’s labour minister, said there had been a modest increase in the number of jobs in the economy during June, July and August, reversing the sharp slump in employment which began last October.

America’s stimlus has also begun to restore growth, but the rise in employment has so far not occured:

Despite an emerging economic expansion, businesses were sufficiently skittish about the future that the job market continued its long, steep decline in August, according to a new government report Friday. The unemployment rate rose to 9.7 percent, from 9.4 percent, as employers shed jobs for the 20th straight month, the Labor Department said.

“Our clients tell us they will not hire in anticipation

of a recovery, but will wait until they see it,” said Jonas Prising, an executive vice president at Manpower, the giant employment services firm. “In a normal recession, people would now start to feel more comfortable and start hiring, but nobody is doing that today. They’ll do it when they see real orders and real business.”

The “silver lining” of the latest unemployment figures is hardly encouraging. The rise in unemployment is not as sharp as over most of the last year. In other words, workers are definitely worse off, but not as badly as they could have been if things were as dismal as they were earlier this year.

While the unemployment rate, as seen on the graph to the right, has risen almost every month since August of 2008, the rate at which the rate has increased has begun to slow. In other words, the economy is probably close to “bottoming out”.

The tally of lost jobs now stands at 6.9 million since the beginning of the recession in December 2007. But the rate of job losses has been declining, if haltingly, since winter. The 216,000 jobs eliminated in August is down from 276,000 cut in July and a peak of 741,000 lost in January.

Here’s what I find most interesting from in the current data. The unemployment rate’s recent rise may actually be a sign that the economy is beginning to recover. Recovery means growth in output, which should mean less unemployment. However, if workers who have been unemployed for a long time, and have therefore stop seeking employment suddenly feel more optimistic about the prospects of getting a job and begin seeking work again, then the nation’s unemployment rate actually rises! How’s that for “silver lining”? The 216,000 additional people added to the list of unemployed may have already been out of work but since they were notactively seeking employment they were not included in last month’s data.

The tricky thing about macroeconomic policy is this:  Monetary and fiscal policies can put billions of dollars into the nation’s banks and households’ and firms’ pockets through tax breaks, government bailouts, subsidies, infrastructure spending and “troubled asset swaps”… but all the money and income in the world will not lead the nation towards full-employment unless the nation’s consumers and producers feel confident. I teach my students that national income is made up of the sum of wages, interest, rent and profit; its spending consists of consumption, investment, government spending and net exports… but without the “big C” of confidence, expansionary policies aimed at increasing employment will come to nought. Confidence, according to John Maynard Keynes, is an animal spirit, a trait of humans beyond the assumption of rational behavior. Until confidence is restored, America’s output and employment levels will remain low.

European governments bail out more lenders – International Herald Tribune

As the US financial system holds its breath to see if the US government’s injection of $700 billion of liquidity actually results in new lending and restored business and consumer confidence, Europe is beginning to see its own government takeovers of European banks.

Regulators in Britain, Belgium and Iceland swooped in Monday to engineer emergency rescues of three banks with heavy exposure to soured mortgages, echoing moves underway in the United States.

In the latest sign of trouble to hit Europe from the global credit crisis, the Belgian, Dutch and Luxembourg governments announced a partial nationalization of the troubled Belgian-Dutch financial conglomerate Fortis, involving a combined injection of €11.2 billion from the three governments, which take a 49 percent stake…

Meanwhile, the British Treasury on Monday confirmed that it had seized the lender Bradford & Bingley – the third British bank to tumble this year – after no private buyers emerged.

Much as in the United States, several European banks have gotten into trouble as their assets tied to real estate have lost value due to the weak European and American real estate markets. As more and more borrowers are unable to pay their mortgages, banks’ assets decline in value and the banks’ willingness and ability to make new loans decreases. This limits the amount of credit available to households and firms, and with it their ability to make investments in consumer goods and capital. Tighter credit markets mean weaker aggregate demand (less consumption and investment), leading to slower or negative economic growth and rising unemployment.

In the past, when one bank got into trouble with bad assets like those tied to the real estate market, other private banks would come along and bail the troubled bank out, swapping cash for the assets, allowing the troubled bank to continue making loans. But when all banks find themselves in the midst of the same financial crisis, the likelihood of finding a private buyer for a struggling bank is low. This is where the government steps in:

The bailout of Fortis (Belgium’s largest commercial bank) orchestrated by the three neighboring countries (Belgium, Luxembourg and the Netherlands) and the ECB (European Central Bank)… was meant to restore confidence in the bank before the reopening of markets on Monday after a tumultuous week of imploding share values at Fortis. The shares gained 4.8 percent to €5.45 Monday.

In Britain, regulators were unable to find buyers to keep Bradford & Bingley afloat. The lender’s shares are down 90 percent from the peak, touching new depths Friday as an already skittish market punished the company, prompting the talks.

When the private sector is unable or unwilling to purchase the assets of a bank that has experienced a write down of its asset value, the government must intervene to make sure such banks have the liquidity (meaning the hard cash) they need to make loans to borrowers, whose spending is needed to keep the economy going.

In the US, the government has agreed to trade $700 billion in hard, loanable and spendable cash, in exchange for financial assets tied to bad mortgages worth something less than $700 billion. If the swap has the effect the government hopes it will, then lending institutions will feel more confidence and be willing to loan cash to each other and to borrowers (households and firms), spending in the economy will increase (consumption and investment) and aggregate demand will rise, meaning more total output, more employment and higher incomes. In addition, more lending will also lead to an increase in the capital stock, effectively pushing the American and European aggregate supply curves outwards, leading to a more stable rate of inflation (a major worry for both economies as oil prices hit record levels this year).

In spite of the recent round of bailouts in both the US and Europe, confidence among European firms and households is low:

Euro-zone economic confidence plunged to its lowest level in seven years in September, the EU said Monday.

A regular survey of European companies and consumers showed the index of confidence in the economy falling to 87.7, close to a 2001 trough, the European Commission said.

The EU executive warned that the survey carried out in the first two weeks of September may not fully reflect growing gloom in the last few weeks as worries over a U.S. and European recession widened on a financial market crisis.

Industry, services and construction were all more pessimistic than a month ago, it said, while consumer confidence was unchanged from a low level. Retailers were slightly more upbeat about their prospects.

It said industry managers’ employment expectations fell – meaning they believe they may have to cut jobs – although services companies were more hopeful.

Consumers thought that unemployment would increase in future months and expect prices to rise.

The 15 nations that share the euro are battling high inflation as oil prices remain high – although below recent record levels – and increasing fears that a financial crisis will freeze or sharply hike the cost of borrowing.

That would slow growth as companies found it harder to get credit and people faced high costs to buy homes. The U.S. government is trying to stave off tighter credit conditions by buying up hundreds of billions of dollars of bad debt from major lenders

As can be seen, falling confidence and tighter credit markets are evil twins. If the Euro zone economy is to avoid recession, the European Central Bank and the governments of the 15 Euro nations should follow closely events in the US over the next few weeks. The $700 billion injection of liquidity, if successful, will act as lubrication in the engine of the US economy.

Think of it this way: lately, the US economic engine has slowed down. Friction in the financial markets has slowed the flow of cash from households to banks to firms and back to households. In IB and AP Economics terms, the circular flow of money and income has slowed to a halt. To get the engine moving again, cash is needed. Banks with liquid cash are more willing to lend to one another and to households and firms. A healthy economy depends on a well lubricated economic engine, which in today’s world means a functioning financial market.

The government bailouts in the US and Europe are intended to do one thing: lubricate that engine and get the economy moving forward once more.

Discussion question:

1. Why does the government need to intervene in financial markets? Shouldn’t those who took risks by making bad loans pay for their mistakes and be allowed to go under?
2. What will it take to turn consumer and investor confidence around in Europe?
3. How might the crisis in the financial markets affect you and me in the real world?

How Does the Stock Market Effect The Economy? | Economics Blog

Well, a few things… Generally, the fluctuations of the stock market do not necessarily bode ill for the whole economy. Likewise, global fluctuations of stock markets does not mean there is a recession on the horizon. In fact, an old adage says that “stock markets have predicted ten out of the last three recessions.” In other words, a slump in global markets does not always precipitate a slump in the world’s economy. Here’s some impacts the market crashes of the last few days may have, however, explained nicely by Richard Pettinger, an economics teacher in the UK:

Economic Effects of Stock Market

1. Wealth Effect: The first impact is that people with shares will see a fall in their wealth. If the fall is significant it will affect their financial outlook. If they are losing money on shares they will be more hesitant to spend money; this can contribute to a fall in consumer spending. However, the effect should not be given too much importance. Often people who buy shares are prepared to lose money; their spending patterns are usually independent of share prices, especially for short term losses.

2. Effect on Pensions: Anybody with a private pension or investment trust will be affected by the stock market, at least indirectly. Pension funds invest a significant part of their funds on the stock market. Therefore, if there is a serious fall in share prices, it reduces the value of pension funds. This means that future pension payouts will be lower. If share prices fall too much, pension funds can struggle to meet their promises. The important thing is the long term movements in the share prices. If share prices fall for a long time then it will definitely affect pension funds and future payouts.

3. Confidence: Often share price movements are reflections of what is happening in the economy. E.g. recent falls are based on fears of a US recession and global slowdown. However, the stock market itself can affect consumer confidence. Bad headlines of falling share prices are another factor which discourage people from spending. On its own it may not have much effect, but combined with falling house prices, share prices can be a discouraging factor.

4. Investment: Falling share prices can hamper firms ability to raise finance on the stock market. Firms who are expanding and wish to borrow often do so by issuing more shares – it provides a low cost way of borrowing more money. However, with falling share prices it becomes much more difficult.

FT.com / Columnists / Wolfgang Munchau – Inflation and the lessons of the 1970s

It seem that everyone’s speculating about the US economy today. Recession or no recession, that is the question. The economy has even surpassed the Iraq War as the number one issue in the US presidential race! John McCain, who has publicly admitted that economics is not his strong suit, may just find himself in trouble in a general election where the most important concern among voters is the economic situation.

So what IS that situation, anyway? Is the US in a recession? In other words, has real gross domestic, or total output in the US economy, actually declined over the last six months? Technically, the answer is no. My fellow blogger, Steve Latter, explains this clearly here. What is true, on the other hand, is that the current situation shares many similarities to the global economic slowdown that did occur in the 1970s.

In 1973 OPEC, the newly formed oil cartel consisting at the time of only Arab states, reduced its output of oil and cut off exports to the United States in response to US support of Israel in the Yom Kippur War, in which the Israelis officially occupied the Palestinian territories of the West Bank and Gaza and seized the Golan Heights from the sovereign nation of Syria. To punish the US for its position on this conflict, OPEC cut off supplies of oil to the west, driving gas and energy prices upwards by 70%, triggering a supply shock characterized by a decline in total output and an increase in both unemployment and inflation, a phenomenon known as stagflation: a macroeconomic policy maker’s worst nightmare.

Recently the world has seen a similar (albeit of a different cause) rise in the price of oil and energy prices. Today the rise in energy prices is driven primarily by rising demand, rather than reduced supply (since the 1970s the OPEC cartel has grown to include many non-Arab nations, making it harder to achieve collusion to restrict output and drive up oil prices). Global demand for oil has risen steadily, driven ever higher due to rapid growth in China and other developing nations, and exacerbated by the falling value of the dollar, the currency in which oil prices are denominated.

The supply shocks of today have combined with falling aggregate demand in the US due to weak consumer spending to slow real growth rates to nearlry 0%. So technically, the US has avoided a recession, but the effect on American workers and consumers may be just as painful as the real recession of the 1970s. In order to prevent the “r” word from becoming a reality today, central banks (including the US Fed) have eased money supplies, lowering interest rates, fueling even greater increases in the price level.

…the global weighted average inflation rate will be 5.4 per cent this year, while the global money market interest rate is currently only 4.3 per cent. This means that global short-term real interest rates are negative – at a time when inflation is rapidly accelerating. As monetary policy has been excessively accommodating for more than a decade, inflationary pressures have built up in the global economy.

Central bankers like Ben Bernanke have to make tough decisions sometimes, weighing the trade-off between unemployment and inflation, and determining their monetary policies based on whatever they deem to be the “lesser of two evils”. Rising energy prices have forced firms to cut either cut back their production and raise the price of their products, both actions that result in less overall spending and output in the economy. Falling house prices have led consumers to cut back their own spending, further reducing demand for firms’ output. These factors have all pushed the unemployment rate from around 4.8% a year ago to 5.1% today, which combined with an estimated additional 3-5% of American workers having dropped out of the workforce, (referred to by the Department of Labor as “discouraged workers”) paints a pretty ugly picture of the reality for the American worker today.

The harsh reality of the weak labor market has led Mr. Bernanke and the Fed to pursue an expansionary monetary policy aimed at avoiding further increases in the unemployment rate and decreases in the GDP growth rate. Expansionary monetary policy means lower interest rates, with the goal being increased consumption and investment, both factors that could worsen the inflation problem already experienced thanks to the global supply shock. Evidence indicates that the inflation problem, even in the US where slow growth usually leads to lower price levels, is not going away:

In the US, a survey-based measure of inflationary expectations recently showed an increase to more than 5 per cent. I would estimate there are now several hundred basis points of difference between the current Fed funds rate and an interest rate that would be consistent with price stability in the medium term.

…meaning the Fed, in its attempt to avoid recession and rising unemployment, has created a condition where real interest rates are actually negative, a highly inflationary condition. All this wouldn’t be so bad if wages in the US were rising along with the price level. This however, does not appear to be happening:

The main difference between the situation in the 1970s and now is today’s absence of wage inflation, which explains why absolute inflation rates are a little more moderate. I guess this is probably because of some combination of deregulated labour markets and globalisation. But the lack of wage-push inflation is not necessarily good news. Falling real wages mean falling disposable income and tighter credit conditions mean less borrowing for consumption.

Rising prices for energy, transportation and food have put American households in a tough situation. In the past, periods of inflation have often been characterized by rising wages, meaning the full brunt of nominal price level increases was not entirely born by the American worker. Today, on the other hand, a recession has thus far been avoided, but the combination of record numbers of “discouraged workers”, rising unemployment and inflation may make the pain of our current economic situation just as real as recessions of the past.

In the words of billionaire investor and economic sage Warren Buffett just today:

“I believe that we are already in a recession… Perhaps not in the sense as defined by economists. … But people are already feeling the effects of a recession.”

“It will be deeper and longer than what many think,” he added.

Discussion Questions:

1. What is the difference between nominal and real GDP? Which must decline in order for the economy to be in a recession?
2. What impact do rising energy prices have on the behavior of individual firms?
3. Why are low interest rates likely to make the inflation problem even worse?

Job losses worst in five years – Mar. 7, 2008

The news late last week out of Washington was not what the White House was hoping for only a couple of weeks after the passing of a fiscal stimulus package meant to achieve exactly the opposite of what has happened. The US Labor Department released its latest numbers on employment on Friday:

There was a net loss of 63,000 jobs, which is the biggest decline since March 2003 and weaker than the revised 22,000 jobs lost in January. Economists had forecast a gain of 25,000 jobs…

“Based on today’s Employment Report, if we are not in a recession, it is a darned good imitation of one,” said Kevin Giddis, managing director of fixed income at Morgan Keegan.

So with a net loss of jobs, it may seem weird to hear that unemployment has actually fallen from 4.9% to 4.8%. How is this possible? In this case lower unemployment may indicate an even worse reality for the American economy:

The unemployment rate fell because of an increase of 450,000 people whom the government no longer counts as being part of the labor force for a variety of factors, such as that they are not currently looking for work. That drop in the size of the labor force allowed for the modest decline in unemployment, even as the household survey showed 255,000 fewer Americans with jobs than in January.

Discouraged workers point to a deep pessimism underlying households and workers in America, indicating that if we’re not already in a recession, it is only a matter of time. With the apparent failure of fiscal policy at achieving any immediate turnaround in consumer confidence, all eye’s are now on the Fed, America’s central bank, to see how Ben Bernanke will respond to the latest round of bad news.

“Even the silver lining of a falling unemployment rate has a little rust,” said Rich Yamarone, director of economic research at Argus Research. He predicted that the central bank will cut rates by a half percentage point at both its March meeting and again on April 30.

But Yamarone and some other experts questioned whether additional Fed cuts would do much to improve the employment outlook.

“We’re not in a crisis because the cost of borrowing is too high, it’s because people are afraid of lending,” said Dan Alpert, managing director of Westwood Capital, referring to the ongoing credit crunch. “At the end of the day, the Fed cuts don’t really solve the problems. They’ve already cut allot; if jobs continue to decline in face of further interest rate cuts, it’s prima facie evidence cuts aren’t effective.”

But few experts were ready to suggest the Fed would stop cutting rates at this point, given the problems in the economy and financial markets.

“The Fed has to do what it can to provide remedy and not scare the market as well,” said Mike Materasso, a senior portfolio manager at Franklin Templeton.

Central bankers face difficult decisions in times like these. While unemployment and falling growth rates pose significant problems to the American economy, the third macroeconomic evil is certainly in the minds of policymakers when deciding how to deal with the first two: inflation.

In order to lower interest rates, the Fed first has to implement expansionary monetary policy. In other words, the central bank must increase America’s money supply. How does it do this, exactly? Most commonly, the Fed uses open market operations, which is a fancy way of saying the Fed buys and sells government securities (treasury notes, bonds, etc…) on the bond market. When the Fed wishes to lower interest rates, it must inject new money into the economy, which it does by buying government bonds from the holders of those securities; namely, the public.

American banks, households, and firms, as well as foreigners all hold government debt. When the Fed wants to expand the money supply, it simply starts buying these debt securities back from the public. The increase in demand for securities drives up their prices, encouraging holders of the debt to sell their securities to the Fed, for which they receive money in exchange. In effect, the public exchanges illiquid (unspendable) debt certificates for liquid money. Now consumers have more money in their pockets to spend, firms have more to invest, and banks have more to loan out to borrowers who want to spend and invest. How do banks get rid of their new liquidity? Yep, they lower their interest rates.

In a nutshell, that’s how monetary policy works. To combat a recession and rising unemployment, the Fed simply buys bonds on the open market, injecting liquidity into the economy, which should result in more borrowing and more spending, shifting aggregate demand out, leading to growth and rising employment.

But what about that third evil, inflation? Won’t more spending lead to demand pull inflation? Usually this is not a major concern in times of a slowdown, since rising unemployment indicates the economy is producing below its full employment level of output. Expanding aggregate demand should result in increased output and stable prices. Today, however, Americans are facing other inflationary pressures, including a historically weak dollar (meaning imported goods and raw materials are more expensive than ever), and skyrocketing food and energy prices due to rising global demand for such commodities.

This all makes the job of monetary policy exceptionally challenging for Mr. Bernanke and his colleagues at the Fed. Expand the money supply too much (i.e. lower interest rates too much) and you risk accellerating inflation. Keep rates too high, and we can expect even worse employment and output numbers in the next few months.

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Promotional Fax Mistaken for Bomb Threat – washingtonpost.com

I don’t know, but I would say the American people are a little on edge these days. What does it say about our society when a paranoid bank employee receives a fax and calls in the bomb squad? The arrival of the threatening fax coincided with the arrival of a “suspicious” package, escalating the fears of the terrified bank staff. Turns out the fax was from the corporate office, and the package contained some paper files, but by the time police figured it out 15 local businesses and a nearby day care’s 30 children had been evacuated from the area!

Okay, so this story may not appear to have much to do with our Econ course… or does it?

Discussion questions*:

1. What impact might mass paranoia about terrorism have on the macro economy? Explain.
2. Would the free market provide the security and protection needed to ensure a healthy and safe environment for investment? Why or why not?
3. What is the term for a service or product that provides spillover benefits for society but which is under-provided by the free market (such as a police force)?
4. Do you think the bank employees were right to be frightened by the threatening fax? Is their fear rational or irrational given the political and social climate in America today?

*From now on, most of the posts on this blog will include discussion questions. These are meant to help students start their own discussion about the issues raised in the posts and how they connect to our economics course. Posts like this one are tagged with a category, and next year when we get to a particular topic in our Econ course, students will be asked to find a past post from that category on the blog, read it and post their comments. This will become a part of students’ grades. To see how the blog will graded, click here.

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