20 posts categorized "Aggregate Demand and Aggregate Supply"


Is 2% the New Benchmark? I Hope Not.

GDP growth continues to disappoint. Today's advance estimate from the BEA pegs real GDP growth at just 1.22% in the second quarter.  Further, the new report revises the first quarter rate down to just 0.8 percent.  Ooof.  The graph below shows quarterly growth rates in real GDP since the beginning of 2006.
Quaterly GDP July 2016
Before the Great Recession, we got used to an average of 3% real GDP growth for decade after decade.  But since that recession ended, real GDP has grown at just 2% per year. The last four quarters are now: 1.99%, 0.87%, 0.83%, and 1.22%.  A decade ago, we'd consider that a horrible year. 
So why isn't there more concern? Because unemployment rates have been consistently around 5 percent.  But don't forget about the very low labor force participation rate, which is below 63% and this past year has been lower than at any time since the 1970s.  So maybe this is the new normal: 2 percent real GDP growth, 5% unemployment, and millions of workers sitting on the sidelines.  I hope not. 


Is the Unemployment Rate Really 4.9 Percent?

A first glance at last week's jobs report might lead you to believe that all is well in the U.S. economy - and perhaps that is true.  But there are recurring indications that some long-term negative trends may persist. 

Let's start with the good news.  The unemployment rate dropped to 4.9 percent, the lowest level since February 2008.  Back then, the economy was entering the Great Recession and the unemployment rate rose to 7.3% by the end of that year.  The graph below shows the unemployment rate since 2005.  It really is nice to see the steady declines over the past five years. 


In addition, the 151,000 now jobs added to nonfarm employment extends a streak of more than five years now (since October 2010) of gains in nonfarm employment.  So the total number of jobs is growing and the unemployment rate is dropping.  What can possibly be bad about the labor market?

Digging a little deeper, we see continued evidence of a disturbing long-term trend that many economists are watching closely.  In particular, the labor force participation rate (LFPR) is still very low as more than 94 million remain outside the labor force.  The graph below shows the labor force participation rate going back twenty years to January 1996.


I've covered this before (see here and here), but a quick review is in order.  When the LFPR falls, it means that some work-eligible adults are no longer working or actively seeking work.  But it also means that GDP is being produced by a smaller fraction of the population.  More and more people are "sitting on the sidelines."   

Where are all these potential workers?  Economists are still teasing out the answer, but one big reason is demographic and the other big reason is a weak macroeconomy.  The demographic piece is due to the aging labor force: baby-boomers are now retiring and this will continue for the next 15 years.  But, as you can see in the graphic above, the weak economy drove many workers out of the labor force and many have not re-entered.  For many, job prospects are just not as good as they were prior to the Great Recession. 

This biases the unemployment rate downward.  Imagine the LFPR rose again to pre-Great Recession levels. In December 2007, at the onset of the Great Recession, the LFPR was 66 percent.  If the LFPR climbed to 66% again tomorrow, more than 8 million workers would enter the labor force.  If none of these workers found jobs, this would drive the unemployment rate up to 9.65 percent.  More realistically, if half the workers found jobs, the unemployment rate would climb to 7.34 percent.  That seems more in line with the economy I live in. 

The bottom line is that the economy is not doing as well as the unemployment data indicates.  Much of the reason why we only see 4.9% unemployment is because the labor force has shrunk.  Let's hope this is not a permanent change. of late. 


GDP 2015: Not so Great

This morning, the BEA released the Advance Estimate of GDP for 2015, and boy is it disappointing.  Keep in mind that this estimate is early and will be revised over the next few months.  But still, 0.7% growth for the fourth quarter is positively pedestrian.  In addition, with all four quarters now in, the overall growth rate of real GDP for 2015 is estimated at just 2.4%.  Yuck.  These are the kinds of numbers that give fodder to those who think we are headed toward a recession.

The graph below shows quarterly growth rates since 2005.  As you can see, only the second quarter was above the long run average of 3 percent. 


Finally, the table below shows the contribution to the overall 2015 growth rate from each of the four types of spending: consumption, investment, government, and net exports. 


I certainly hope that these figures are revised upward over the next few months.  In the immediate future, I'll be very curious to see the jobs report from the BLS next week. 



College Students Need Macroeconomics Principles

Should we ditch macroeconomics or perhaps reduce it to two weeks?  In a recent blog post, Noah Smith argues that most of the material in a Principles of Macroeconomics class isn’t really necessary.  After teaching macro principles to more than 1,000 students per year since 2003, it is easy for me to find the blind spots in Noah’s view.  More than anything, it is pretty clear that Noah doesn’t spend much time with college students. 

Let me start with what Noah gets right: students should learn the Solow model for long-run growth, and the AD-AS model for business cycle analysis.  He also includes “the standard Milton Friedman, New Keynesian, AD-AS, accelerationist Phillips Curve theory of monetary policy.”

Now we come to Noah’s first howler: he believes that this material should take “about two weeks.”  Two?  What students is he teaching?  I teach at the University of Virginia, a really great university with super students.  But this takes six weeks, not two. When my students show up for macro principles, very few even know that interest rates are market prices.  I do teach the Solow model but most Macro principles instructors believe it is just too hard for the intro level. 

More than that, Noah leaves out a host of other macro topics that students need to learn at the intro level, whether they continue in economics or not.  This list includes:

1. Key macroeconomic variables.  These need to be defined, explained, and put in their proper historical perspective.  These include real GDP growth, unemployment, inflation, and interest rates.  And not just for the United States.

First off, the way we measure these variables actually matters.  Consider that unemployment rates do not include underemployed or out-of-labor force workers.  Or that GDP only includes market goods.  Both of these are relevant for policy and have been discussed in the media recently.  And historical perspective is really key here – it can be one of the best gifts you can give your students. What is a big number or a small number?  When unemployment is 7%, is that high or low?  How about in the U.S. versus Spain?  Or when real GDP grows by 4%, is that high or low?  How about the U.S. versus Mainland China?  Most college students won’t know this without a macro principles course.

2. The loanable funds market. You can’t understand financial collapse/contagion without a good understanding of the loanable funds market.  A big part of this discussion is also forming an intuitive understanding of interest rates, which is not natural for most students.  In my principles course (and textbook) I even cover mortgage-backed securities, securitization and moral hazard now so that the students understand the Great Recession.

3. Fiscal and monetary policy. In many universities, this is the one place where real economic policy is taught - Intermediate Macroeconomics typically focuses on theoretical models.  I view these policy discussions as voter education curriculum.  Students need to know what deficits mean and something about historical perspective here too.  They also need to know where government revenue comes from and how it is spent.  Hint: it’s not all spent on foreign aid and welfare!  And what about the Fed? This is the course where students learn about Fed policy and both actual and perceived effects on the economy. 

If time permits, it is great to also throw in international trade and finance, like the balance of payments (many misconceptions arise from a misunderstanding of how capital inflows are related to merchandise trade). 

Basically, to cover all of this takes about a semester.  It is foolish to think that two weeks is enough.

By the way, my favorite macro textbook covers all of these topics clearly in a great one-semester format.


GDP Third Quarter 2015

The latest GDP release from the BEA estimates that U.S.real GDP grew at 1.5% in the third quarter of 2015.  This is just a mediocre growth rate but revisions to second quarter data have now increased the final growth estimate to a robust 3.9 percent.


Recall that inventory is part of investment expenditures in GDP.  In the second quarter, private inventories fell by 1.44%.  This drop was the biggest negative of the major pieces of GDP.  In total, investment fell by about 1% in the third quarter.  The table below shows how the four major pieces of GDP each contributed to third quarter growth.




Why Is Unemployment so High in Spain?

Do you think it is hard to find a job in the United States? Try looking in Spain, where youth (15-24 years old) unemployment rates have exceeded 50% since 2012.  The figure below shows youth unemployment for both Spain and the United States beginning in 1995.  Even when Spain was experiencing strong economic growth from 1995 to 2008, youth unemployment rates were around 20 percent!

Spain Youth Unemployment

But it is not just rough for the youth of Spain: the figure below shows overall unemployment rates in Spain, which consistently dwarf those from the United States. 

Spain Unemployment

Economists believe the main reasons for these differences are labor market regulations in Spain – regulations that were actually put in place to help workers.

For example, mandated severance pay in Spain is particularly generous.  Until 2012, any Spanish firm that wished to fire a worker was required to continue to pay them for 45 days for every year they were employed.  Thus, if a firm wanted to fire a ten-year employee, they’d have to pay them for 450 days after their employment ended.  This regulation make it very difficult for young workers to break into the labor force.  They also incentivize firms to search longer for just the right worker to fill open positions.  Both of these increase frictional unemployment.  In 2012 this requirement was reduced to 20 days of pay for every year of employment.

Another regulation is mandated annual increases in wages and benefits.  That is, firms are required by law to give pay and benefits raises every year.  Think about this from the firm’s perspective: before you ever hire and retain a worker for more than a year, you will be sure they are worthy of their current pay plus raises.  These regulations increase the time firms spend searching for just the right match, and again, increase frictional unemployment.

Remember: Incentives affect behavior.

All of this data is available from the Organization for Economic Co-operation and Development (OECD).


Ho-Hum Growth in Second Quarter

Today, the BEA released their  first (Advance) GDP estimate for the second quarter of 2015, estimating real GDP growth of 2.3%.  These figures will be revised over the next few months, but for now, they indicate positive but pedestrian growth below the long-run historical average of 3%.  The graph below shows quarterly real GDP growth since the beginning of 2004.

 GDP 2q2015

The big news is that the growth estimates for the first quarter of this year were revised up to +0.6% from -0.2%.  This means that the economy has had positive growth now for over a year.

The table below shows the contributions of each of the four major pieces of GDP:

Growth components


GDP Down in First Quarter (Again)

Real GDP in the U.S. fell by 0.7% in the first quarter of 2015, according to the latest report from the BEA.  The graph below shows growth by quarters since the beginning of 2005.


It seems reasonable to ask: what is wrong with the first quarter?  After all, since 2010, there have only been three quarters where U.S. real GDP has been negative - and these were the first quarters of the years 2011, 2014, and 2015. 

Economists are of three views on this.  The first two are summarized well by Justin Wolfers here. One is that there are exogenous random shocks have hit the economy, and this has lately been in the first quarter. An example is bad weather (think polar vortex). Second, it is possible that the BEA is not correctly measuring the seasonal adjustments in the first quarter of data.  In other words, the GDP estimate is just wrong.

Finally, Tyler Cowen posits that maybe the economy does naturally go through a seasonal cycle after all.  Perhaps this is related to a lull after the holiday season.  From this view, the first quarter downturn is accurate and should not be smoothed out of the data with seasonal adjustments.

Whatever the case, we can all agree to hope for a large uptick in the second quarter.


Unemployment Rate Steady but Job Losses in Oil Extraction

The  unemployment rate in remained steady at 5.5% in March.  The graph below shows the steady decline over the past year, falling from  6.6% one year ago.  The number of long-term unemployed also stayed constant in March. However, this number decreased by 1.1 million over the past year.

Unemployment rate mar 2015

Jobs growth did slow in March, with just 126,000 new jobs. This is down from an average of 269,000 new jobs per month over the past twelve months.

Nonfarm payroll mar 2015

There is at least one very good economics lesson in this report:  Employment in mining actually fell by 11,000 jobs in March.  The BLS report states that the employment declines "were concentrated in support activities for mining, which includes support for oil and gas extraction."  Thus the lost jobs are a direct result of the falling gasoline prices over the first few months of this year. 











Sex, Drugs and GDP in Europe

In September,  Eurostat waved a magic wand and increased the GDP in the European Union by 3.53 percent overnight. That is a full year's worth of very solid growth.  But it didn't make Europeans any wealthier because it was actually just due to a new definition of the way GDP is counted.  Eurostat (the economic statistics office of the European Commission) redefined GDP to include many transactions that were previously uncounted and are actually illegal across much of the Eurozone.
The new GDP definition includes illegal drug deals, prostitution, and even sales of stolen goods. Specifically, it includes illegal transactions as long as both parties agree to the transaction.
European-cannabis-lawsOstensibly, Eurostat is trying to capture part of the shadow economy that is typically not measured in GDP.  This makes sense, right? GDP is supposed to measure the output of final goods and services, so shouldn't we include all final goods and services even if the service is illegal?  In addition, this is complicated when the legality of goods and services varies across nations.  For example, the map to the right (from Wikimedia Commons) shows how cannabis laws vary across Europe - cannabis is essentially legal in some nations like the Netherlands but strictly illegal in others like France. 
So, normalizing the accounting standards across nations makes sense. But these illegal activities are difficult to measure.  In addition, if the illegal activities are a relatively stable portion of GDP, then there is really no bias when they are not included.  In fact, the new estimates, in an attempt to provide a more complete measure, may actually introduce more error into GDP measurement due to the difficulty of estimating illegal trade.  
So why the change in definition? There is another, perhaps insincere rationale: the new GDP measurements are a bit of an accounting trick to help nations lower their deficit to GDP ratios.  Many European nations are dealing with high deficit (and debt) to GDP ratios. The European Commission has explicit rules regarding these budget measures: a nation's deficit in a given fiscal year is not to exceed 3% of  their GDP, and the national debt is not to exceed 60% of GDP.  When nations exceed these bounds, the Council is directed to bring coercive measures called Excessive Deficit Procedures (EDRs). The Council has certainly been lax in enforcing these EDRs in recent years.  However, increasing GDP by simply redefining how it is measured automatically lowers deficit and debt ratios and helps nations with higher government debt levels. 
The figure below shows the effect of the new GDP definition on the GDP level each nation in 2013 (along with the overall EU and Euroarea).  The countries are ordered according to their GDP gains from the ESA 2010.
GDP percentage change ESA 10 mac
As you can see, GDP for Cyprus jumped 9.8% exclusively due to this accounting change.  This re-definition of GDP then shrank the debt-to-GDP ratio in Cyprus by a full half of a percentage point in 2013 - reducing it from 5.4% to 4.9%.  Therefore, this accounting rule change exaggerates any debt reduction in Cyprus, as they (hopefully) move closer to the EU goal of 3 percent.
So while new GDP accounting rules in Europe may normalize national income accounting across the continent, they are particularly helpful to those nations that already have high government debt levels.

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