Daniel K Tarullo: Unemployment, the labor market, and the economy
Speech by Mr Daniel K Tarullo, Member of the Board of Governors of the Federal Reserve
System, at the World Leaders Forum, Columbia University, New York, 20 October 2011.
* * *
I appreciate the opportunity to be at Columbia this evening to discuss the American economy
and, in particular, the employment situation.1 Mindful of the trend of public discourse toward
hyperbole, I hesitated in deciding whether to characterize that situation as a crisis. But it is
hard to justify characterizing in any less urgent fashion the circumstances of the nearly
30 million Americans who are officially unemployed, out of the labor force but wanting jobs,
or involuntarily working only part time.
This situation reflects acute problems in labor markets, created by the financial crisis and the
recession that followed. But we also confront chronic labor market problems. In my remarks
this evening, I will outline both sets of problems. In my observations on policy responses,
however, I will concentrate on the acute problems - in part to join the debate on their origins,
in part because they call for the most immediate response, and in part because they are
most relevant to my monetary policy responsibilities as a member of the Federal Open
Market Committee (FOMC) of the Federal Reserve. That said, I hope you will not think the
chronic problems any less important for the briefer treatment they receive tonight.
Most of what I have to say can be summarized in three points. First, the acute problems are
largely, though not completely, the result of a shortfall of aggregate demand following the
financial crisis and recession. As such, they can be addressed through measures designed
to increase total investment and consumption spending in the economy.
Second, because the recession arose from a financial crisis, which itself followed a buildup of
asset bubbles and unsustainable debt in important areas such as housing, the policies likely
to be most effective at increasing aggregate demand may be somewhat different from those
associated with a more typical recession and, even so, are not likely to work as quickly.
Third, if labor market conditions remain this unfavorable for a long period, the problems I
have described as acute could transform into another chronic problem. I refer not just to the
despair and desperation that workers and their families must feel as weeks of unemployment
stretch into months and even years, which alone should be enough to elicit a policy
response, but also to what occurs when the ranks of the unemployed remain so great for so
long - the erosion of skills and labor market attachment may affect the productive capacity of
the economy as a whole.
The state of the labor market today
Let me start with some basic statistics that summarize the current state of the labor market.
The most familiar of these is the unemployment rate, which, except for a couple of months
earlier this year, has been at or above 9 percent since mid-2009. This is only the second time
since the Great Depression that the jobless rate has been so high, and it is the first time
since the 1930s that it has been so high for so long. Unemployment rates are exceptionally
elevated for certain subgroups of the population: Nearly 15 percent for workers without a
high school education, 16 percent among African Americans, about 25 percent among all
teenagers, and nearly 50 percent for African American teenagers. Even among college
graduates, whose unemployment rate is much lower than that of the population as a whole,
the rate has doubled since the onset of the recession.
As familiar as the unemployment rate is, both as a measure of economic slack and as an
indicator of the pain experienced by American households, it does not tell the whole story.
About 9 million workers who would like a full-time job can find only part-time work. Millions of
others are working at jobs for which they are likely overqualified and earning less than in their
previous jobs. Meanwhile, another 6 million people who are not officially counted among the
unemployed say that they would like a job but have stopped looking for one, in many cases
because they have become discouraged by the poor state of the job market.
This effect can also be seen in the labor force participation rate, which has dropped sharply
since 2007. The proportion of the U.S. population that is employed now stands at about
58 percent, the lowest level since 1983. Finally, more than 6 million workers - nearly one-half
of all the unemployed - have been jobless for more than six months. The long-term
unemployment rate is by far the highest it has been since data on the duration of
unemployment began to be collected in 1948.
Even more dispiriting than this snapshot of the employment picture is that there is so little
momentum toward improvements in labor market conditions. The level of payroll employment
fell by nearly 9 million during and just after the recession. To date, only about one-fourth that
number of jobs has been restored. The pace of job growth in recent quarters has been barely
enough to absorb the increase in the labor force and wholly insufficient to produce
meaningful declines in unemployment. The number of new claims for unemployment
insurance suggests only modest gains in employment in coming months, while measures of
job vacancies seem to have turned down.
Longer-term concerns for the U.S. labor market
Persistent employment weakness during an economic recovery, even such a tepid one,
raises the important question of whether it is symptomatic of longer-run changes in the labor
market. Indeed, in some respects the recent weakness resembles the "jobless" recoveries
that followed the 1990 and 2001 recessions. In both of those episodes, job growth remained
weak well after the downturn in real gross domestic product (GDP) ended, and the
unemployment rate continued to rise, though from lower levels than we have today. One
might reasonably ask if these similarities suggest that structural changes have placed the
labor market on a permanently lower growth path.
A first response is that there are important differences between this recovery and the
recoveries that followed those earlier recessions. In particular, some explanations offered for
the weak labor market recovery following the past two recessions are clearly not relevant
today. Both the 1990 and 2001 recessions were relatively shallow downturns. This factor
may have allowed more of the employment adjustment to occur through attrition, which can
be spread over a longer period than layoffs. And both of those recessions followed long
expansions, which may have permitted a buildup of productive inefficiencies that gave
businesses scope to increase output in the subsequent recovery without expanding
employment.2
That said, there are some discouraging longer-term trends. Even before the recession, the
labor market seemed to be on a slower trajectory than in previous decades. Between the
business cycle peak in early 2001 and the peak in late 2007, the number of payroll jobs rose
an average of only about 0.6 percent per year, compared with job growth of 1.8 percent per
year in both the 1980s and 1990s. Similarly, the labor force participation rate and the
percentage of the population employed each peaked around 2000 and have been on a
downtrend path since then. It is true that a good part of this change can be accounted for by
demographic factors - notably, lower population growth, the aging of the baby boom, and the
leveling off of participation rates among women. But other, more disquieting factors are also
at work.
Two tendencies in particular suggest that the U.S. labor market has lost some of the
dynamism that had long contributed to its resilience. First, it is apparent that job reallocation
- that is, the sum of the jobs created at some businesses and lost in others - has been in
secular decline since the late 1990s. It may seem counterintuitive to include lost jobs in a
measure of labor market health, and on its own it is obviously not such an indicator. But
when combined with new jobs, it forms part of the dynamic of job reallocation, an important
part of the "creative destruction" that contributes to long-run economic growth - for example,
as jobs shift from less-productive firms to more-productive ones.
Second, the amount of employee movement across jobs has fallen over time. Specifically,
the rate at which workers move from one firm to another has declined. So has the rate at
which workers quit jobs, an indication of the degree to which they believe there are better
jobs available for them. In what may be a related trend, geographic mobility across counties
and states has decreased.3
Longer-term patterns in the types of jobs being created have also contributed to a widening
gap in wages and income between the richest and poorest Americans. Adjusting for inflation,
earnings for a worker in the middle of the wage distribution have risen about 10 percent since
1980, while earnings for a highly paid worker at the 90th percentile of the wage distribution
have risen more than 30 percent during the same period. Earnings for workers near the low
end of the distribution - those around the 10th percentile - have risen only about 5 percent
after taking inflation into account. Thus, as has been widely observed, the gains from
economic growth over the past three decades have disproportionately accrued to the highest
wage earners.
To some degree, growing wage inequality reflects rising returns to education. Since 1980,
the average wage for college graduates has increased from about one and a half times the
average wage for workers with only a high school degree to about two times their wage. The
good news is that this rise has encouraged more young Americans to enroll in college. The
fraction of 18- and 19-year-old high school graduates who are enrolled in college rose from
around 50 percent in 1980 to nearly 70 percent today. Even the good news must be
qualified, however, since half this rise took place in the 1980s, and the pace of increase has
slowed since then. The bad news is that less-educated adults with significant work
experience and younger, inexperienced adults who are ill prepared for, or unable to afford,
college may be increasingly excluded from future economic gains.
This widening inequality has been described as the result of a broader trend toward
"occupational polarization."4 This theory posits that the diffusion of computer-related
technologies, the related automation of routine work, and an increased capability for firms to
move their activities offshore have combined to concentrate job creation in the poles of either
high-skill, high-wage employment or low-skill, low-wage work. The high-skill occupations
increasingly require at least a bachelor's degree. Demand has shifted away from traditional
middle-class occupations. The kinds of workers who would have been employed in a
traditional manufacturing or administrative job now often end up in lower-paying jobs.
Younger workers have historically filled many of the lower-paying service-sector jobs that are
now more likely to be taken by less-educated adults. Thus, occupational polarization may be
responsible for some of the rapid decline in employment and labor force participation among
young people over the past decade. While part of this decline is likely attributable to the
pursuit of additional education, employment and participation rates have also fallen for those
youth who are not attending school, suggesting that education-related explanations are not
the whole story. Indeed, research by the Federal Reserve Board's staff has found that
greater crowding-out from adults can account for much of the decline in youth participation.5
This crowding-out may have undesirable long-term consequences for the current generation
of younger adults, as some research finds that poor job opportunities early in one's working
life can lead to lower employment and wage rates in the future.6
The aggregate demand shortfall
To this point, I have portrayed a labor market still disabled by the trauma of the financial
crisis and the recession that followed, but also beset by chronic maladies whose symptoms
predate the crisis. In considering the nature and magnitude of appropriate policy responses,
an important question is the extent to which the current high level of unemployment reflects a
shortfall in aggregate demand rather than additional structural problems arising from the
recession. If the high level of unemployment is predominantly structural in origin, then the
increase in aggregate demand intended by various monetary and fiscal policies would
presumably be of limited efficacy.
Although structural problems likely account for some of the high jobless rate, I believe the
evidence points to aggregate demand as clearly the more important explanation. On its face,
the sheer magnitude of the decline in the number of jobs during the recession, the speed of
the increase in unemployment, and the halting nature of the economic recovery together
create a fairly strong presumption that insufficient aggregate demand is the most significant
factor. Moreover, one thing that the current episode has in common with the previous two
"jobless" recoveries is a slow rebound in aggregate economic activity. Over the first eight
quarters of all three recoveries, real GDP grew at an average annual rate of 3 percent or
less, compared, for example, with more than 5 percent in the two years following the 1975
and 1982 recessions. Even taking into account differences in trends across time, the slower
pace of overall economic growth following recent recessions is striking.
Various arguments have been advanced in an effort to rebut the presumption that an
aggregate demand shortfall accounts for much or most of the increased unemployment. The
most common argument is that the deep recession created serious difficulties in matching
available workers to available jobs, resulting in a big increase in structural unemployment.
The mismatches in question could develop for a number of reasons. First, some have
suggested that the traditional willingness of American workers to move from weaker labor
markets to stronger ones has been impeded by the sharp decline in residential property
prices and especially by the large number of mortgages that are now greater than the values
of the properties securing them. But research to date suggests that such "house lock" has
probably not had more than a small effect on structural unemployment thus far.7 As noted
earlier, migration rates have been falling for some time. But the declines during the recession
have not been larger for homeowners than for renters. Nor has migration declined more in
areas where workers are more likely to have underwater mortgages because of particularly
large declines in housing prices.
A second factor, the one most often cited in support of the structural unemployment
hypothesis, is skills mismatch. While it is quite plausible that certain features of the current
labor market reflect some skills mismatch contributing to a rise in structural unemployment
during the recession, closer examination reveals that they explain less of this increase than
might first appear.
One such labor market feature is the sharp reduction in employment in sectors related to the
housing bubble, such as residential construction and some parts of financial services. The
contention is that the skills of workers in these sectors do not readily transfer to other
sectors, and thus they will have a particularly difficult time finding new jobs. But in every
recession, certain industries and occupations are hit particularly hard, resulting in significant
permanent job losses. Yet previous recessions do not seem to have been accompanied by
notable increases in structural unemployment. Thus, those who believe the mismatch
problem specifically created by the recession - as distinguished from more-secular trends -
is either more prevalent or more persistent now than in the past would need to identify some
additional source of rigidity that has further hampered labor market adjustment.
Some have also pointed to the high level of long-term unemployment as evidence that
mismatch is a major factor keeping the unemployment rate high. The claim is that those
without the skills sought by employers will take longer, on average, to find new employment.
However, the data do not back this claim, at least to date. If high unemployment durations
were the result of mismatch, the probability of finding a new job should have declined
proportionately more for the long-term unemployed than for the recently unemployed. In fact,
reemployment probabilities during the recession fell by similar amounts for all durations of
unemployment and have edged up by similar increments in the recovery. Again, this pattern
is more consistent with weak aggregate demand being the most important cause of high
unemployment.
Another argument for the structural unemployment hypothesis is that the relationship
between job vacancies and unemployment has recently changed. Generally, job vacancies
bear an inverse relationship to the unemployment rate; that is, when the unemployment rate
is low, vacancies are relatively plentiful, and when unemployment is high, vacancies are
scarce. The pattern of these changes over time has been plotted on what is commonly
referred to as the Beveridge curve. A stylized interpretation is that movements along the
downward-sloping Beveridge curve are generally caused by changes in aggregate demand.
Persistent shifts of the curve closer to, or further away from, the vertical and horizontal axes
may reflect structural changes in the labor market.
Much has been made of the fact that the Beveridge curve appears to have shifted out in the
past couple of years. The argument is that the shift reflects an increase in job mismatch, with
the vacancies going unfilled because of structural reasons such as lack of geographic
mobility or appropriate skills.
I think far too much has been made of this argument. In the first place, the Bureau of Labor
Statistics data series from which the Beveridge curve is constructed began only in 2000.
Researchers at the Federal Reserve Banks of Cleveland and San Francisco used other data
sources to draw what we might call "approximate Beveridge curves" for the post-World War II
period.8 They found that, during and immediately after the serious recessions from 1973 to
'75 and from 1981 to '82, the curve also shifted out noticeably, but in both cases it shifted
back inward during the recovery. Why this occurred is not so clear. The big increase in job
loss during the recession is probably a factor, as sharp increases in layoffs overwhelm the
matching process. It may also be that during serious downturns, more workers who would
have given up looking for a job continue to look in order to qualify for extended and
emergency unemployment benefits, or that employers take longer to fill vacancies when the
labor market is weak.9
An analysis by Federal Reserve Board economists that decomposes the shift in the
Beveridge curve into its various components does point to some increase in structural
unemployment related to a reduction in the efficiency with which unemployed workers are
matched to vacant jobs - that is, mismatch.10 However, the estimated increase is fairly
modest - on the order of 1 percentage point - relative to the total increase in the
unemployment rate experienced in recent years. The remainder appears mainly related to
the delays in filling open positions that I mentioned a moment ago.
Economists at the Federal Reserve Bank of New York conducted a broader study of the
mismatch issue. By examining imbalances between the occupations, industries, and
geographic locations in which vacancies are concentrated and those in which unemployment
is concentrated, they constructed an index of potential mismatch. They, too, concluded that
mismatches accounted for only a small amount of the increase in the unemployment rate
during the recession - on the order of 3/4 to 1-1/2 percentage points.11
In sum, I do not think arguments suggesting that structural factors account for most of the
increase in unemployment are persuasive, either individually or collectively. Our efforts to
quantify the increase in structural unemployment since the onset of the recession find that it
accounts for less than one-fourth of the difference between today's unemployment rate and
that which prevailed in the pre-crisis years.
Before leaving this subject, I want to mention a different version of the structural
unemployment argument, which is the concern that high unemployment today will result in an
increase in structural unemployment in the future - a form of the phenomenon known as
8
See John Lindner and Murat Tasci (2010), "Has the Beveridge Curve Shifted?" Federal Reserve Bank of
Cleveland, Economic Trends, August 10; and Robert Valletta and Katherine Kuang (2010), "Is Structural
Unemployment on the Rise? (PDF)" Federal Reserve Bank of San Francisco, FRBSF Economic Letter
2010-34 (November 8).
9
On the effects of unemployment benefits, see Robert Valletta and Katherine Kuang (2010), "Extended
Unemployment and UI Benefits (PDF)," Federal Reserve Bank of San Francisco, FRBSF Economic Letter
2010-12 (April 19). On the lag between job vacancies and hiring, see Steven J. Davis, R. Jason Faberman,
and John C. Haltiwanger (2010), "The Establishment-Level Behavior of Vacancies and Hiring," NBER Working
Paper Series 16265 (Cambridge, Mass.: National Bureau of Economic Research, August).
10
See Regis Barnichon and Andrew Figura (2010), "What Drives Movements in the Unemployment Rate? A
Decomposition of the Beveridge Curve," Finance and Economics Discussion Series 2010-48 (Washington:
Board of Governors of the Federal Reserve System, August).
11
See Aysegül Sahin, Joseph Song, Giorgio Topa, and Giovanni L. Violante (2011), "Measuring Mismatch in the
U.S. Labor Market (PDF)," unpublished paper, Federal Reserve Bank of New York, July.
hysteresis. The unusually long duration of unemployment spells and high fraction of the labor
force unemployed for more than six months raise the prospect that the long-term
unemployed will become progressively less employable as their skills, reputations, and
networks deteriorate. That is, the distinction between cyclical and structural unemployment
may begin to blur. In the aggregate, such effects could result in a persistently higher level of
structural unemployment, a persistently lower rate of labor force participation, and a
concomitant decline in the level of potential output of the entire economy. Whole cadres of
workers, whether younger people leaving school at a time of high unemployment or older
workers losing long-time jobs, might never regain the career trajectory on which they were
headed.
In the past, such effects do not appear to have been very significant in the United States, and
there is little evidence that they have taken hold today. But the current unprecedented
durations of unemployment may reduce the relevance of historical experience. Even if the
rise in structural unemployment is relatively modest to date, the longer the labor market
remains weak, the greater the risk that structural unemployment will become more of a
problem. Of course, if anything, this possibility argues for more-aggressive policies to reduce
unemployment sooner.12
Effective policy responses
The policy issues presented by today's labor market problems are challenging, to say the
least. There is need, and ample room, for additional measures to increase aggregate
demand in the near to medium term, particularly in light of the limited upside risks to inflation
over the medium term.
Unlike in the aftermath of the steep recessions of the mid-1970s and early 1980s, demand
growth has not become sufficiently self-sustaining to produce the strong recovery that
followed those earlier episodes. Of the nine quarters that have passed since positive GDP
growth reappeared in the third quarter of 2009, the rate of growth was significantly above
trend in only three - the fourth quarter of 2009 and the first two quarters of 2010. These
quarters were probably the first to benefit significantly from the effects of the American
Recovery and Reinvestment Act, passed earlier in 2009.
Up until quite recently, the dominant metaphor one heard for the economy was that it was on
its way to a healthy recovery but was hitting occasional "soft patches." This reading of the
data always seemed to me quite optimistic. Now, I believe, nearly everyone has toned down
their expectations. I think the better metaphor is of an economy slogging through the mud
and occasionally hitting stretches of dry pavement, which may well have been associated
with the peak effects of fiscal and monetary policy initiatives. The economy's difficulty in
gaining traction is, of course, due in no small part to the continued high levels of
unemployment and underemployment, which constrain demand through both direct effects
on household income and indirect effects in sapping consumer confidence.
12
Another line of argument is that the sluggish recovery in the labor market, and in the economy more generally,
is a result of wage rigidity. According to this view, prospective workers are unwilling to accept wage rates low
enough to induce businesses to hire and increase production. However, it is hard to see why this phenomenon
would be any stronger now than in earlier recessions, when a greater fraction of the U.S. workforce was
covered by collective-bargaining agreements. Moreover, there would seem to be little indication in the wage
data to support the idea that wage rigidity is having a major influence on unemployment. Wage rates have
decelerated across a broad range of industries and occupations, and unit labor costs have fallen sharply. A
simple histogram of the distribution of nominal wage changes in recent years does show a spike at zero,
indicating some resistance to reductions in nominal wage rates, but the spike does not seem particularly large
relative to those in earlier recessions. In any case, because the difficulties suggested by this argument arise
from the interaction between nominal wage rigidity and a deficiency of aggregate demand, the most
straightforward way to overcome problems caused by nominal wage rigidity would be to expand aggregate
demand.
Yet it seems quite likely that there is something at work beyond an adverse feedback loop
involving personal consumption expenditures, investment, and employment. The obvious
candidate for that additional factor is the high amount of debt - particularly household debt -
that accumulated before the financial crisis. With the bursting of the housing bubble, debt
levels that may have looked manageable to consumers who believed their homes were
appreciating suddenly appeared burdensome as house prices declined. In some parts of the
country, this decline was dizzyingly rapid. There has been some progress in working off or
writing down some forms of debt, such as credit card balances. But housing continues to
hang like an albatross around the necks of homeowners and the economy as a whole, with
millions of underwater mortgages, a staggering inventory of foreclosed homes, and
depressed levels of sales.
What, then, are the policies best suited to increase aggregate demand? It must first be said
that neither monetary nor fiscal policy will be able to fill the whole aggregate demand shortfall
quickly. But appropriate policies could surely boost output and employment. There have also
been suggestions that attempts to boost aggregate demand will be unsuccessful when the
amount of debt overhang is significant. I agree that without more effective efforts to address
the manifold problems affecting the housing market, there is a good chance that the recovery
will lack strong momentum for some time to come. But aggregate demand policies are still
important. For one thing, debts will surely be less burdensome as incomes rise. Moreover,
the confluence of housing debt and aggregate demand problems suggests that particular
attention should be paid to policies that could buttress aggregate demand while addressing
at least some housing market problems.
As you know, the FOMC has maintained the federal funds rate near zero for almost three
years in response to the extraordinary economic and financial problems faced by the country.
With short-term rates already about as low as they can go, the FOMC has also taken some
unconventional measures to provide additional monetary accommodation. The combined
effect of these monetary policies helped stabilize financial markets in 2009, hold deflation at
bay in 2010, and support a modest recovery. But, in the absence of favorable developments
in the coming months, there will be a strong case for additional measures.
Some have argued that monetary policy should do no more, and that the political branches of
government should adopt fiscal or other policies to encourage increased economic activity
and job creation. I certainly do not disagree that well-conceived policies by other parts of the
government could produce gains in employment, investment, and spending. But the absence
of such policies cannot be an excuse for the Federal Reserve to ignore its own statutory
mandate. The Federal Reserve Act requires that the FOMC promote the goals of maximum
employment and stable prices. The statute does not qualify that mandate by saying that we
should promote these goals only if all parts of the government - or, for that matter, the
private sector - are acting just the way we think they should. In other words, we have to take
the world as we find it and adjust our actions accordingly. Sometimes that will mean tighter
monetary policy to offset the inflationary effects of other policies. Sometimes, as at present, it
will mean more accommodative policies, even when we know that monetary policy alone
cannot solve all the economy's problems.
Within the FOMC and in the broader policy community, there has been considerable
discussion of possible additional accommodative measures, from communication strategies
such as forward guidance on the likely path of the federal funds rate to additional balance
sheet operations. I believe we should move back up toward the top of the list of options the
large-scale purchase of additional mortgage-backed securities (MBS), something the FOMC
first did in November 2008 and then in greater amounts beginning in March 2009 in order to
provide more support to mortgage lending and housing markets.
In November 2010, when the FOMC initiated another large-scale asset purchase program,
only U.S. Treasury securities were involved, in large part because of a desire to return, once
the recovery was well established, as quickly as possible to a Federal Reserve balance
sheet that did not contain other kinds of assets. A related concern of some was that the
purchase of MBS was a form of credit allocation, rather than simply monetary policy that
lowered long-term rates for all borrowers. For similar reasons, the proceeds of agency
securities accumulated pursuant to the first large-scale asset purchase program were
reinvested in Treasury securities rather than in other agency securities.
At the September FOMC meeting, we changed our reinvestment policy so that the proceeds
of maturing agency securities will now be reinvested in new MBS. Yields on longer-duration
Treasury securities had trended down appreciably in the late summer in response to market
demand, safe-haven flows, and diminishing expectations for growth. Even though nominal
MBS rates had also declined somewhat, spreads to Treasury yields had, over the course of
the year, widened noticeably. Since this announced change in reinvestment policy, spreads
on lower-coupon MBS have narrowed, but they remain higher than they were early this year.
A large-scale MBS purchase program has many of the benefits associated with purchases of
longer-duration Treasury securities, such as inducing investors to shift to other assets,
including bonds and equities. But it could also have more direct effects on the housing
market. By increasing demand for MBS, such a program should reduce the effective yield on
those MBS, which in turn should put downward pressure on mortgage rates. The aggregate
demand effect should be felt not just in new home purchases, but also in the added
purchasing power of existing homeowners who are able to refinance. Indeed, homeowners
who refinance get the equivalent of a permanent tax cut.13 C