The Economy and Higher Education
Forum for the Future of Higher Education
The Brookings Institution
Washington, DC
January 23, 2013
Outlook for the Economy and Financial Markets
Barry Bosworth, Donald Kohn and Charles Schultze
Karen Dynan, Moderator
Introduction
MS. DYNAN: To set the stage I’m going to offer a few thoughts on the current state of the economy. If you look at chart 1 you’ll see a graph of real GDPs. That’s the real goods and services that our economy is producing. You can see on this graph that real GDP is rising and that’s a good thing, but it’s well below where it would have been if we had continued on the trend that we were on before the recession hit. The recession is shaded on the chart.
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Chart 1:
14.0
13.5
13.0
12.5
12.0
11.5
11.0
10.5
10.0
2000 2002
2004 2006
2010
2008
Moreover, population has been growing over this period so real GDP per capital, real GDP per person, is actually still below where it was at its peak more than five years ago. You can see GDP growth rates in chart 2. You can see where they’ve been in recent quarters.
Chart 2:
10.0
10.00
8.00
5.0
6.00
0.0
4.00
-5.0
2.00
-10.0
2000 2002 2004 2006 2008 2010
Shaded areas mark recessions; last data point: September 2012
0.00
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Most forecasters are calling for GDP to grow about 2 percent in 2013, which the Fed would call moderate growth; it’s a good thing that we’re seeing growth but it’s not terrific.
Now if you look at chart 3 you can see the path of GDP and some of its important components in a typical recovery.
Chart 3:
10%
5%
0%
GDP
Consumption
Nonresidential investment
Residential investment
-5%
-10%
0 1 2 3 4 5 quarters from peak
6 7 8
Going across the horizontal axis you can see quarters from the peak and then everything is anchored to be zero at the peak of the economy. But if you just look at the GDP line, the black line, it takes a little more than a year for GDP to get back to its prerecession levels. But it does get back there. And looking at the components you can see that residential investment typically leads the way in a recovery.
If you look at chart 4, that graph shows the experience in
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the current business cycle.
Chart 4:
5%
-5%
-15%
-25%
-35%
GDP
Consumption
Nonresidential investment
Residential investment
-45%
0 2 4 6 8 10 12 quarters from peak
14 16
If you look at the percent change from the peak we’re talking about a much wider scale here on the vertical access than the previous chart, which is telling you it was a much deeper plunge relative to typical recessions in the past. And then I want you to also notice, if you move across the horizontal axis, that it took us much longer to get back to the prerecession level of output-- three to four years. And by looking at the components of GDP you can see that investment, both nonresidential residential -- have not recovered as in previous recoveries.
Then just flip to the second page on the labor markets. Now I want to make a few points about the labor markets. The first point is jobs are being created. So like GDP, payrolls are growing. We’ve created about
150,000 jobs a month over the past -- on average over the past three months. You can see in chart 5 that the
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unemployment rate has come down.
Chart 5:
20
Unemployment Rate Underemployment Rate
Shaded areas mark recessions; last data point: December
2012
It’s come down from 10 percent at its peak to just under 8 percent now. So again, these are good things but it’s really not all good. We’re still a long way from the precrisis norm, which was something like 5 percent. Maybe there’s a new normal that’s 6 or above 6 but we’re still a long way from being normal.
Moreover, a lot of the drop we’ve seen in the unemployment rate is not actually because unemployed people have found jobs; it’s because they’ve dropped out of the labor force. Chart 6 shows the labor force participation rate. You can see that there’s just been this enormous decline in the labor force participation rate, putting it at its lowest level in 35 years.
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Chart 6:
Participation Rate Employment to Population Ratio
67
63
59
55
1963 1973 1983 1993 2003
Shaded areas mark recessions; last data point: December 2012
Economists fight about what the labor force participation rate would be if we hadn’t seen the Great Recession? And the truth is that demographics probably would have caused the labor force participation to drop a bit. But most of the drop we’ve seen is probably a cyclical phenomenon.
Based on an estimate that the Hamilton Project has done at Brookings, we need to create 11 million jobs to get us back to normal job growth. And if you’re only creating 150,000 jobs a month it’s going to take you a long time, years and years, to get there. The bottom-line is that things are getting better in the economy but not very fast.
So with that introduction, we’re going to start off with Don Kohn, who is going to cover our financial market issues.
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Donald Kohn
MR. KOHN: Thanks, Karen. And great to be here. I will start with chart 7.
Chart 7:
10.0
8.0
USA Germany UK
6.0
4.0
2.0
0.0
1996 1999 2002 2005 2008
Shading marks recessions; last data point: January 18, 2013
2011
As you can see, and as you are well aware, interest rates are at incredibly low levels, certainly the lowest in many, many decades. Financial and credit market conditions are mostly very easy, although I will make a bit of a differentiation between what’s going on in the credit markets and what’s going on in the banking system in a second. So 10-year government bonds are less than 2 percent; about 185, 190. That’s up a few basis points from a couple weeks ago but still really, really low. .
But it’s not just the government debt. Interest rates are very low. If you look at chart 8, the BAA corporate bonds have also fallen very, very far.
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Chart 8:
10.0
9.0
8.0
7.0
6.0
5.0
4.0
1996 1999 2002 2005 2008 2011
Shading marks recessions; last data point: January 18, 2013
It’s less than 5 percent; about 460. So the low rates on government bonds are feeding through to rates on other types of borrowing, especially for businesses. Now, one reason that nominal interest rates are so low is that inflation has been low. But it’s not just inflation that’s low. Real interest rates, the rate of return after taking out the increase in the price level, has been extremely low. In fact, 10-year government bonds are at a negative real interest, -0.65. And those rates are encouraging quite a bit of issuance by corporations-- record levels of issuance by nonfinancial corporations of bonds.
Corporations are terming out their debt. They’re building cash reserves and they’re taking advantage of these very low interest rates to do that. And I think that suggests that although the government is borrowing a lot of money, when the economy has so much slack in it there really is no crowding out of private borrowing. There’s extra capacity there.
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Low interest rates are helping to push up stock prices, as you can see in chart 9, as have good profits, good corporate profits as well. And that lowers the cost of equity capital for businesses. It should encourage them to spend. And it raises household wealth to the extent that households ultimately hold equity and that should encourage spending as well.
Chart 9:
20,000
15,000
10,000
5,000
0
1996 1999 2002 2005 2008 2011
Shading marks recessions; last data point: January 18, 2013
Although bond markets, the financial markets are very, very easy and accommodative, the banking system is less so these days. Chart 10 shows the proportion of banks tightening standards on consumer and business loans, and you can see the huge spike in the middle of the crisis.
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Chart 10:
100
50
Credit cards
Other consumer Commercial
0
-50
1993 1996 1999 2002
Last data point: December 2012
2005 2008 2011
When bank lending virtually shut down, banks got so worried and so conservative they tightened quite substantially.
Things have eased off some, and probably we should be very happy as taxpayers that they haven’t eased off entirely because clearly bank credit was way too available before the crisis. Banks got themselves in situations that were not sustainable. The Y-axis is the percent of banks reporting that they eased or tightened credit. If you look at the peak that’s 70 percent of banks -- and there are about 50 banks in the sample, and they’re the largest banks that the Fed surveys.
You can see there’s some easing off of the very tight credit, particularly on business credit; because business loans are growing very rapidly, about 11 percent last year. But in both commercial and residential real estate, banks are remaining very, very cautious in their lending, and that’s impeding the recovery in those sectors.
They’ve eased off a little in consumer credit as well, but
I think things remain pretty tight. Consumer loans increased 1 percent last year -- only 1 percent last year
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after decreasing 3-1/2 percent the previous year. So I think the bottom-line here is that for businesses, credit is easily available from banks or relatively easily available in the markets. Small businesses may be hurt a little bit, but for consumers credit conditions are still kind of tight.
One reason interest rates are so low is Federal
Reserve policy, as you can see in Chart 11. The Federal
Reserve, by legislation, has two objectives. One is maximum employment, which is defined as the lowest sustainable unemployment that doesn’t generate a lot of inflation. As Karen noted, people thought that was about a
5 percent unemployment rate before. It may be somewhere closer to 6, between 5-1/2 and 6 now, but we’re a long way from that. We’re close to 8 percent and there’s at least 2 percentage points of space to lower the unemployment rate.
As you can see in Chart 11 the Federal Reserve is projecting the unemployment rate comes down very slowly and doesn’t hit 6 percent until 2015 or after 2015. This is a range of projections.
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Chart: 11
FOMC Economic
Projections
Central Tendency
2013 2014 2015
Change in real GDP 2.3 to 3 to
3 3.5
3 to
3.7
Unemployment rate 7.4 to 6.8 to 6 to
7.7 7.3 6.6
PCE inflation 1.3 to 1.5 to 1.7 to
2 2 2
Core PCE inflation 1.6 to 1.6 to 1.8 to
1.9 2 2
The other goal of the Federal Reserve is stable prices, which they track with the personal consumption expenditure chain weighted index. The Fed has defined their goal as a 2 percent inflation rate. Why not zero?
One is measurement error in the indexes, but the other one is you want to have some small level of inflation holding up these nominal interest rates so that when something bad happens to the economy the Fed can ease those rates and ease monetary policy. I’ll come back to that in a second.
But as you can see in the third line of Chart 12, the Fed projects that we will be at or below its price stability objective over the next three years.
So we have a situation in which we’re missing unemployment on the high side and prices on the low side.
Ordinarily, if I were at the Federal Reserve and we were going into an Open Market Committee meeting and the
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projections were for high unemployment and inflation below my target I’d say let’s lower interest rates. Let’s drop the federal funds rate, which is the normal instrument we used to use. But look at chart 12, the federal funds rate is already at zero.
Chart: 12
8
6
4
2
0
2001 2003 2005 2007 2009 2011
Shading marks recessions; last data point: December 2012
So the Fed, since the winter of ’08, spring of ’09, when that interest rate hit zero, has been faced with a dilemma.
The economy needs stimulus if we’re to accomplish what
Congress wants us to accomplish, but we’ve run out of room in our normal instrument.
So the Fed decided to buy intermediate and longterm debt. So how can we lower the interest rates out the yield curve? We can do it by buying those securities, driving up the price, driving down the interest rate. You can do it another way, too. You can tell people, “I, the
Federal Reserve, plan to hold these interest rates near zero, for a long time now.” And as you tell them how long you plan to hold interest rates near zero, they will revise down their expectations of when interest rates will go up.
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That will tend to lower intermediate and long-term interest rates.
So how is this supposed to help the economy?
There are three channels for easier monetary policy to help the economy. Let’s think about in the old days when the federal funds rate came down. If the Fed reduced the federal funds rate, people basically factored that through their expectations for future federal funds rates, future interest rates, and intermediate and long-term rates went down. That obviously makes it easier to borrow, makes it cheaper to borrow. You might have been debating whether to buy that house or that car. Now that you can borrow more cheaply; it tilts the decision towards buying.
There are two more channels though. Lower interest rates tend to push up wealth, tend to push up equity prices and housing prices, so people feel wealthier when interest rates come down. If you feel wealthier, if your 401K is higher, if your house is worth more, you feel like you can spend at least a little bit of that; the empirical evidence is a dollar of wealth increases spending by about 4 cents a year. So as interest rates go down, wealth goes up, people spend more. The final channel is through the exchange rate. As interest rates go down, interest rates in the U.S. go down relative to other countries; people tend to take their money out of the U.S. and invest in other countries. That lowers the exchange rate. What will that do? That will make exports from the
U.S. more desirable and imports from other countries less desirable, which will help shift spending towards the
United States. So there are three basic channels for monetary policy. They work on short-term rates and they work the same way with intermediate- and long-term rates.
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So what is the Fed trying to do by buying securities and telling people about what interest rates are going to be? They’re trying to lower those intermediate and long-term rates and work through the same channels of cost to capital, wealth, and exchange rate they are working through before.
As you see in chart 13, the Fed has been buying
Treasury securities and buying mortgage-backed securities.
They are buying $85 billion of additional securities a month. So if that chart were projected out that line would start rising again. And the point is to put downward pressure on interest rates.
Chart 13:
4,000
3,000
Agency Debt & MBS
Lending to Nonbank Credit Markets
Short-Term Lending to Financials
Other
2,000
1,000
0
2008 2009 2010
Last data point: January 16, 2013
2011 2012
In December the Fed made an interesting change.
Previously the Fed would say “we’ll buy X hundred billion dollars of securities” and “we’re going to keep interest rates low at least until the middle of 2013, or the end of
2014.” But now they are keeping the amounts and the dates
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open ended. They said, “We are going to keep buying securities until we can see an outlook for substantial improvement in the labor market.”
Picking up on Karen’s earlier points about how poor this labor market had been, the Fed is concerned that the longer the labor market is weak the more likely that cyclical unemployment turns into structural unemployment.
People drop out, they lose their skills. The idea is to get that unemployment rate down as quickly as possible, so they are going to keep buying securities. They’re not even going to discuss not buying securities until they see the forecast that the unemployment rate is going to drop and drop substantially and improve.
And the second thing they said was -- we’re going to keep easing until the labor market improves, until the unemployment rate drops below 6-1/2 percent and/or the inflation rate hits 2-1/2 percent. So they are willing to take a chance that the inflation rate might exceed the 2 percent target for a short period of time in order to get this unemployment rate down. They’re taking risks on the side of getting the unemployment rate down. They want to avoid any chance that they might tighten prematurely.
Is it working? I think there are two elements to that. The first is, are these low interest rates driving financial conditions in the market? I do think the Fed’s efforts have put a huge downward pressure on interest rates throughout the economy and helped to raise asset prices -- houses as well as equity.
The second element is, are those changes in financial conditions feeding through to spending? That’s a much harder question. We can measure the changes in the asset prices. But we can’t really know the counterfactual;
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that is, what would have happened if the Fed hadn’t done what it did to asset prices. I think the logic is that it is having some effect. People are buying more autos, the decline in mortgage rates has helped the housing market to recover. But it’s very hard to prove.
And it could be that the affect diminishes over time.
After all, as you lower interest rates you’re trying to induce people to spend today, you’re bringing spending forward from the future to the present. The more you do that, and the deeper you ask them to dig into the pile of potential future spending, the harder it is to get them to spend. So I think it’s doing some good. How much is an open question; and how much additional actions would affect spending is also an open question.
I’ll conclude there. Thank you.
MS. DYNAN: Thanks. We have Charlie up next who is going to talk about factors holding back the economy, particularly in the medium term.
Charles Schultze
MR. SCHULTZE: I want to talk about the major factors affecting the medium-term outlook for the U.S. economy -- let’s say the next two to three years. Let’s start with the demand side of the economy. We’re now more than three years into a disappointingly slow recovery. We’re growing slowly not because the economy is unable to produce enough; rather, the demand for goods and services has fallen behind our ability to supply them. There’s a gap between what we could produce and sell if businesses were operating with high employment and reasonably full use of our productive capacity.
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I want to concentrate my remarks on some of the major components of demand. I’ll be talking about consumption purchases, business investment and plant and equipment, residential construction, and exports. It’s possible that a prolonged period of insufficient demand with high and long-lived unemployment as we now have could erode our supply potential, which is the limit of our ability to produce goods and services without driving up inflation. If I have time I’ll say a little bit about that possibility. Let’s start with chart 14.
Chart 14:
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GDP
Cycle Peak = 100
4
106
104
3
102
2
100
98
1
96 0
0 2 4 6
8 10 12 0
In my first appearance in front of this group three years ago I used this chart from an IMF study of some 200 recessions in modern times among advanced countries. It highlights not only the unusual severity of losses and output in employment that are associated with financial
2 4 6 8
10 12
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crises, but also the sluggishness of the ensuing recovery.
And notice that after a financial crisis unemployment gets hit relatively more than output. And, as virtually everyone knows, the unusual depth of the 2007 recession was set in motion by the collapse of bloated housing prices, fed by the deterioration of underwriting standards, especially for financing subprime housing. The still sluggish recovery is due in part to borrowers’ efforts to reduce their spending and lenders tightening their lending standards in the process known as deleveraging. It’s a very painful process and it takes much longer than most people would have thought.
Chart 15 shows the recovery in auto sales and housing in states with high household leveraging and states with low household leveraging. You can see the big difference in the two circumstances. It’s one indication of the impact of deleveraging.
Chart: 15
So far, the overall extent of deleveraging mortgage debt has been modest. As of late last year, the
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total value of outstanding home mortgages, including home equity loans, was only a shade below where it was at the peak of the boom in 2006. But the overall value of household real estate has fallen by $5.5 trillion. That’s a very substantial number relative to consumer disposable income.
As of the third quarter of last year, some 14 million U.S. households, 28 percent of the total, were underwater. Their mortgages were larger than the value of their homes. And while housing prices have fallen dramatically in the recession, they haven’t fallen much below their historical relationship with average household incomes and rental values. It’s just that the run up got us so far out of line. On that basis I wouldn’t expect to see substantial increase in housing prices to get people out of their deleveraging problems.
Clearly, the deleveraging won’t go on forever.
The growth in population and even a modestly rising household income will generate a demand for new housing construction. Housing starts rose modestly in 2011 and in the first nine months of 2012, and new starts sped up in the last quarter of 2012. But the level of starts at
780,000 houses built a year is still far below the annual average of 1.5 million houses in the 30 years prior to the
Great Recession, not counting the boom years just prior to the collapse. Even if starts should continue to increase at the speed they did in 2012, and particularly the late part of 2012, it would still take until 2017 before they got back to the 1.5 million level.
Let me turn now to business investment, which is plant and equipment investment, which typically makes an important contribution to a healthy recovery from a
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recession. After a steep decline during the recent recession, business investment began to pick up in 2009, as you can see in Chart 16.
Chart 16:
30
20
10
0
-10
-20
-30
3Q
-40
1/q/2007 1/q/2008 1/q/2009 1/q/2010 1/q/2011 1/q/2012
But business investment has contributed much less than in other recoveries over the past 30 years to the growth in
GDP. The one exception was even smaller growth during the
2000 recession recovery, but that was a very shallow recession that didn’t have far to go to resume normal performance.
If you look at the chart, you can see, the sharp fall back in the growth rate of business investment over
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the past year. By the third quarter of 2011, some two years after the trough of our steepest recession, the annual growth rate of business investment had risen a sizeable 20 percent annual rate. But in the year since then that growth rate has fallen steadily every quarter to what is now a slight negative Since quarterly measures of business investment do tend to fluctuate pretty substantially, even a year of increasingly small advances need not inevitably imply continuing weakness.
On the other hand, venture capital investments are particularly sensitive to events that increase uncertainty about the stability of the economic environment. Such investments stopped growing in the year
2012 and fell in the fourth quarter relative to a year ago.
It’s possible that the yearlong decline in the growth rate of business investment is, to some extent, attributable to economic uncertainty caused by political deadlock over major changes in federal tax and expenditure policy, as well as the extension of the federal debt limit.
I tend to be somewhat leery of assigning too much importance to hard-to-predict outcomes of political standoffs. On the other hand, the fall to a zero growth rate in business investment, plus the venture capital decline, are likely to weigh on the economy’s output over the next few years.
Let’s turn to exports. As you’ll see in chart
17, U.S. exports in inflation-adjusted dollars fell sharply by some 20 percent in the recession but reversed course in mid-2009; they rose at an equally steep pace until about a year and a half ago. Since then, the growth has settled down to a much reduced pace of a little less than 4 percent a year.
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Chart 17:
60
40
20
0
160
Index of
140 peakpea
120
100
80
trough Slowdown slow tr o
Ряд1
Given the forecast for a minor recession in the Eurozone and a somewhat reduced pace for Eastern Asia, I don’t see anything to suggest a major change in U.S. exports over the next several years. While recent months have seen some easing in the government debt and banking problems, and the
ECB Central Bank has been given some important powers to strengthen its ability to intervene in the economy, the fundamental flaws of the economic structure still exist -- the rigidity of their currency. It’s very hard to get around the problem of your unit labor cost going up too fast. Couple that with the absence of a central fiscal policy and you’ve got some real structural problems. At the moment the problem seems to have become somewhat better over the last six months, but those fundamental flaws still
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exist. So I’m still uncomfortable about the long-term stability of the arrangement and the possibility of macro consequences.
Let me turn to consumer spending. Over the past five quarters, consumer spending has been a remarkably constant fraction of consumers’ disposable income -- earned income after taxes plus government entitlement payments.
And consumption has been an unusually stable fraction of that. And the personal saving rate out of that income has also remained about the same. However, given the continuing political impasse over the federal budget it appears there will be changes in consumer income and perhaps other taxes, as well as in government transfer payments such as Medicare and food stamps. These are likely to change the consumption ratios.
One way to sum this all up is the following: I don’t have much reason to believe that the slow pace of this recovery is likely to speed up significantly in the next few years. But nor do I think we’ve got a second dip coming.
Ideally -- but I stress ideally but probably politically impossible -- is an immediate dose of fiscal stimulus phased to try again to push the economy out of this very slow recovery. I would like to see the longer term and the short term melded together so you get your austerity for the long-term debt problem phased in very gradually and a shorter-term stimulus enacted. I say ideally. In fact, it’s not going to happen.
Finally, chart 18 is on long-term unemployment.
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Chart 18
45 percent
(Recessions beginning from 1957
20
15
10
5
40
35
30
25
Trend from 1958 thru
201
0
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
You can see what’s happened to long-term unemployment. For years, the U.S. distinguished itself from Europe by the fact that when we did have recessions, the unemployment was mostly short-term. Conversely, European unemployment was much longer term than ours, with much less mobility. We have now fallen into that, at least in this recovery.
There is some possibility that this long-term unemployment can affect our longer-term growth given the impact on both the quantity and the quality of the labor force. For example, people who left a firm with substantial tenure and are unemployed for six months find it harder and harder to get jobs; employers are much more reluctant to take someone with that kind of a history.
On the other hand, there is not yet a consensus on terms of how important this is.
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MS. DYNAN: Thanks, Charlie. Barry is going to be speaking next.
Barry Bosworth
MR. BOSWORTH: On the global economy, let me just make a couple of points. One is I think the world economy over the last year has stabilized to a considerable extent. The problem is that it stabilized at a very low rate of growth.
The problems that have plagued the United States have now spread worldwide; basically, the developing countries found themselves too dependent on trying to finance or export to the advanced economies and growth in those economies is no longer rapid enough to support the prior levels of exports.
So all the developing countries are now experiencing a significant slowing of their growth.
Europe has died out of the news, and I do think the possibility of a near-term financial crisis has declined in Europe considerably, particularly because the
European Central Bank has just said they will finance unlimited amounts of money for as long as necessary. But is there any economic recovery coming in Europe? No. Instead, the economic recession in Europe is spreading to other countries. It’s important to remember that in several
European countries now it looks like the Great Depression of the 1930s. In Spain and in Greece and in Portugal, and not quiet yet in Ireland but soon, the unemployment rate in those countries is 25 percent, and teenage or young adult unemployment rates are 50 percent. It’s really hard to see how those societies can continue much longer with that sort of difficulty.
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In the United States we have a growth rate sufficient to maintain a constant rate of unemployment but we’re not going to make any significant progress in reducing the unemployment in the near future. But I think the United States has something to learn from the experience of Japan. When this started it reminded me so much of what happened in Japan in the 1990s, and the more it goes on, the more it looks the same. The United States risks going through a lot of the same experience as Japan.
And now I think we have the Japanese case in political terms as well. They could never decide whether the fundamental problem was budget deficits or the lack of growth in the economy and the high levels of unutilized resources. So they flip-flopped back and forth from one to the other; increasingly, the Japanese experience looks like that’s what the American experience is going to be. The political winds right now are shifting. Now our biggest problem is budget deficits, and we will go through a period of reducing the budget deficit. Then the economy will slow even more, then people will get sucked the other way and try to go back. We have the same handicap that the
Japanese had. We have no monetary policy to counter all these trends because it’s been effectively neutralized by the collapse of interest rates to low levels.
I think people underestimate the extent of the crisis that’s spread worldwide. Interest rates are not zero just in the United States; they’re zero in major money markets all around the world. I think we underestimate how much this has become a global episode of extremely slow growth looks like it’s going to be sustained for some period of time.
It’s a lot easier to deal with a budget deficit
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in a growing economy, and the United States is making a big mistake not to focus on trying to restore economic growth and get the unemployment rate back down. It’s very hard, as Europe has taught us again, to do something about fiscal problems in the midst of a recession. You just make the recession worse. So Europe is suffering in many countries from the effort to have fiscal austerity in the midst of a weak economy, and it made the economy even weaker.
For a substantial number of us in the United
States, the economic crisis has passed. Times aren’t good but they’re not terrible. You see a shift in public momentum towards thinking that the fundamental problem is the budget deficit, not about the economy. The economy seems to have sunk pretty low on the list of public concerns here in the United States, and you see similar trends in the rest of the world. That leaves you a little worried about the prospects for any upturn in the economic growth around the world.
I’ll stop with that so we’ve got time for questions.
MR. KOHN: Could I add one point here? I agree the attention now is all on reducing the deficit. There’s an agreement on what our objectives ought to be but there’s virtually no agreement on how we ought to get there.
Discussion
MS. DYNAN: Great. So we have some time for questions.
Yes, over there.
SPEAKER: I’ve wondered if part of the problem is that
29

folks my age are refusing to retire. As a result, we’re still in the workforce taking up a job that could be available to those people who are long-term unemployed or not getting that first job. There seems to be a very different culture around how long you stay in the workforce these days. We can because we’re healthier. We think we need to because of the potential financial risks. And each of those factors means that there are fewer jobs available for the next generation of folks. Is that a factor?
MR. KOHN: Overall, labor force participation has come down, partly because of retirements, moving demographics; partly because of the cycle. And I would expect participation to rise if the economy were able to pick up a little more steam. But society should be able to generate the additional demand to keep not only us employed but the other people who want jobs. It’s an insufficiency of demand. I don’t think extra supply is the real problem.
MR. SCHULTZE: Let me add a footnote. One consequence of that huge growth and length in the duration of unemployment is that people are retiring to get the benefits well before they might have otherwise.
SPEAKER: When the Fed does move away from its easing policies, how well can they manage that? How much should we worry about a rapid increase in interest rates or any other unintended consequences?
MR. KOHN: That’s a very good question and I think one they’re asking themselves. They do have a new tool to raise interest rates, and that’s the interest they pay on
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the deposits that the banks hold at the Federal Reserve.
So you can think of that interest rate as a floor on interest rates. As they raise that floor, that’ll tend to tighten policy. But there are a huge volume of reserves in the system. So I think there are two concerns. One is how accurate can they be when they start raising those rates?
How will that play into short-term rates? Will the big large volume of reserves make it kind of a messy, soggy kind of increase? The Federal Reserve has come up with new ways of absorbing those reserves but we’ve never been in this situation before; we don’t know.
But the second point I’d make is the one that I think you were hinting at. As we get closer to exit and people start anticipating it, intermediate and longer-term interest rates are really going to start ratcheting higher.
They’ve not only held short-term rates low for a while, they’ve been buying those bonds. And when people start anticipating their sales that’s going to start putting upward pressure on those rates in addition to the expected tightening of policy.
My expectation is if the Fed thinks the increase in intermediate and long-term rates is inconsistent with maintaining a good recovery and keeping the unemployment at a reasonably low level, they’ll try and use their words to damp down some of those expectations. But we’ve never been there before. It could be kind of a messy situation. But the important point is they have the tools to tighten when they decide to tighten.
MS. DYNAN: That’s a really interesting point, Don. It seems like there is a coming communications challenge -- challenges that make the current communications challenges
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look kind of moderate. And the chairman’s term is up in a year; right?
MR. KOHN: Right, exactly a year.
MS. DYNAN: So looking for another one is going to be a priority I should expect.
MR. KOHN: Right. Another college professor, perhaps. I don’t know.
MS. DYNAN: That would be wonderful.
SPEAKER: What are some of the available options for addressing the long-term unemployment problem? Which of these options would have the most impact and which are the most politically viable?
MR. SCHULTZE: I brought the subject up but I don’t think I have a very good answer to that question. There’s a good bit of literature on it but not enough to tell me how to answer that question, so I’m kind of freaking out.
MR. BOSWORTH: I would argue there’s not much evidence that’s going to be the long-term problem. If you can get unemployment down -- in other words, create jobs -- the long-term unemployment rate will come down in line with that. It always has in the past. Part of the issue may be that we kept unemployment insurance very long term; people had to report they were unemployed in order to continue to collect the unemployment insurance. In past recessions we’ve done more with job training programs to redirect
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people. But the U.S. experience has been that long-term unemployment doesn’t last as long as there are job opportunities for everybody. Since we don’t have a lot of this safety net that exists in European countries, the
American response has always been to such people, “Get a job.” What we failed to do this time is give them the opportunity to get a job. But I think the focus should still be on trying to create jobs. If we do, I think the historical experience says the long-term unemployment rate will come down in line with that.
MR. KOHN: I agree with Barry that job number one is to get jobs. What we don’t know is how much of this unemployment has turned structural and how much retraining is necessary.
I think that has to be part of the answer. How many of these people who dropped out of the labor force will come back in but need retraining to get those jobs? I think we need to fight it on both fronts.
MS. DYNAN: The sad fact is the literature does not speak that strongly on what works and what doesn’t in terms of retraining folks. Even if it did, I’m not even sure how relevant it would be because the world has changed so much.
We have technological opportunities that make education more flexible, more suited to people’s schedules. So I agree that fixing the short-term unemployment should be job number one, but combating the long-term unemployment may be a little like how we were combating some elements of the financial crisis; throwing a bunch of spaghetti at the wall and seeing what sticks.
MR. SCHULTZE: Can I add something to that, something I’ve
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forgotten?
I did a paper on this some years ago and you’ve got to think of the skills that people have and might lose if they’re unemployed for a long period of time. There are two kinds of skills. One is a general skill. You know, you’re an engineer, you’re a physicist, you work at the lower levels of the health care system.
There’s a second type of skill, and that’s what’s called a firm-specific skill. And it turns out that long tenured workers suffer a much bigger job loss when they get fired than low tenure. There are all kinds of things involved with just being with the firm. You know how the firm operates. You know which supervisors not to pay much attention to and the ones that really know what they’re talking about. You know your consumers. You have idiosyncrasies. All kinds of things that increase your productivity. So this idea of job-specific skills is, I think, very important to how this all works out.
SPEAKER: Could Barry say a little bit more about the prospects for Spain and Portugal and Ireland?
MR. BOSWORTH: There’s been some adjustment of relative wages in these countries, but the extent of over evaluation remains very high. You can point to states in the United
States that this went on for a century. People have been leaving West Virginia, for example, for 100 years. And the real worry is they may continue to do that in Greece for the next 100 years. It just takes a very long time to make these kinds of adjustments. The Europeans made a colossal error, and it’s very hard to recover from it. They should have never formed a union among states that weren’t really
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states. And I don’t see any way for them to get out.
They’re insistent that they will not dissolve the union and let the individual countries adjust their own exchange rates. I agree that now that would be very hard to do and cause another big disaster, but otherwise what do you do?
In the United States people immigrate. And I think in
Europe, unfortunately, that’s the same answer you’re going to get. People will have to immigrate to the prosperous areas because exchange rates -- more accurately wage rates
-- just don’t change very fast. There’s just no lending taking place in Greece. There’s no lending taking place in
Spain. Everybody wants to get their money out. And so there’s just been massive movement of funds out of these countries financed by the European Central Bank. But the banking system is not viable anymore without the day-to-day support of the European Central Bank. I don’t see an easy way to recover from that.
SPEAKER: Most of us in the room are not really engaged in what we would call “training,” but we are engaged in education. Could you tie this into education policy?
There’s this weird sense that unemployment is high and yet in many educated areas unemployment is low and it’s difficult to find enough people. How do you see this playing into any changes in federal education policy and keeping an educated population?
MR. KOHN: I have strong views about that. There’s been a lot of rhetoric around the country that getting a college degree doesn’t pay, basically from parents of children who didn’t get a job the day they got out of university. But if you look at the wage rates, your version is much more
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accurate. The college premium just continues to rise.
There’s a relative shortage of skilled workers. If you think they’re having trouble getting jobs, you ought to see what high school graduates look like.
This is an opportunity to invest more in human capital. And we could do it at a time when the social interest rate is zero. Why doesn’t the country take advantage of the opportunity to borrow funds to put these kids into universities where they could get some investment? Everything we know says that investment will have very high returns in the future. There’s just no evidence that the college premium is declining in the
United States, and I think the prospects that it could happen anytime in the near future are slim.
Just as we should be rebuilding the infrastructure, the physical infrastructure, at a time when the interest rate is zero, we should be doing the same thing with human capital. But all the forces in society are running in exactly the opposite direction. We’ve got to reduce the budget deficit. We have to cut back. It just seems a very weird world that we live in if you contrast the interest rate with what everybody is saying.
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