President Obama’s Essay on Economic Policy after the Election: “The Way Ahead”

The Economist

“The Way Ahead” – President Barack Obama.


Much of the protectionist mood in the US is driven by anti-immigrant sentiment and a resurgence in nativism

“How has a country that has benefited—perhaps more than any other—from immigration, trade and technological innovation suddenly developed a strain of anti-immigrant, anti-innovation protectionism?… Much of this discontent is driven by fears that are not fundamentally economic. The anti-immigrant, anti-Mexican, anti-Muslim and anti-refugee sentiment expressed by some Americans today echoes nativist lurches of the past”


Rise in inequality and slow growth in income for the low- and middle- class has also contributed

“But some of the discontent is rooted in legitimate concerns about long-term economic forces. Decades of declining productivity growth and rising inequality have resulted in slower income growth for low- and middle-income families. Globalisation and automation have weakened the position of workers and their ability to secure a decent wage”


Also a growing resentment of business and political elites

“And the financial crisis of 2008 only seemed to increase the isolation of corporations and elites, who often seem to live by a different set of rules to ordinary citizens.”


Despite these negatives, trade, globalization and technology have been overwhelmingly beneficial to the US

“Over the past 25 years, the proportion of people living in extreme poverty has fallen from nearly 40% to under 10%. Last year, American households enjoyed the largest income gains on record and the poverty rate fell faster than at any point since the 1960s. Wages have risen faster in real terms during this business cycle than in any since the 1970s. These gains would have been impossible without the globalisation and technological transformation that drives some of the anxiety behind our current political debate.”


To restore people’s trust in the forces of capitalism and globalism, the inequality gap needs to be addressed

“Economists have long recognised that markets, left to their own devices, can fail. This can happen through the tendency towards monopoly and rent-seeking that this newspaper has documented, the failure of businesses to take into account the impact of their decisions on others through pollution, the ways in which disparities of information can leave consumers vulnerable to dangerous products or overly expensive health insurance… A world in which 1% of humanity controls as much wealth as the other 99% will never be stable. Gaps between rich and poor are not new but just as the child in a slum can see the skyscraper nearby, technology allows anyone with a smartphone to see how the most privileged live. Expectations rise faster than governments can deliver and a pervasive sense of injustice undermines peoples’ faith in the system.”


Radical change, however, is not the answer

“As appealing as some more radical reforms can sound in the abstract—breaking up all the biggest banks or erecting prohibitively steep tariffs on imports—the economy is not an abstraction. It cannot simply be redesigned wholesale and put back together again without real consequences for real people.”


President Obama advocates fiscal stimulus to boost productivity growth

“A major source of the recent productivity slowdown has been a shortfall of public and private investment caused, in part, by a hangover from the financial crisis. But it has also been caused by self-imposed constraints: an anti-tax ideology that rejects virtually all sources of new public funding; a fixation on deficits at the expense of the deferred maintenance bills we are passing to our children, particularly for infrastructure; and a political system so partisan that previously bipartisan ideas like bridge and airport upgrades are nonstarters.”


Unions flexible enough to not hinder American trade policy, and tax policy are key to addressing inequality

“In the future, we need to be even more aggressive in enacting measures to reverse the decades-long rise in inequality. Unions should play a critical role. They help workers get a bigger slice of the pie but they need to be flexible enough to adapt to global competition. Raising the Federal minimum wage, expanding the Earned Income Tax Credit for workers without dependent children, limiting tax breaks for high-income households, preventing colleges from pricing out hardworking students, and ensuring men and women get equal pay for equal work would help to move us in the right direction too.”


New trade deals— the Trans-Pacific Partnership and the Transatlatnic Trade and Investment Partnership— will make American firms more productive and lift wages for workers

“Lifting productivity and wages also depends on creating a global race to the top in rules for trade. While some communities have suffered from foreign competition, trade has helped our economy much more than it has hurt. Exports helped lead us out of the recession. American firms that export pay their workers up to 18% more on average than companies that do not, according to a report by my Council of Economic Advisers. So, I will keep pushing for Congress to pass the Trans-Pacific Partnership and to conclude a Transatlantic Trade and Investment Partnership with the EU. These agreements, and stepped-up trade enforcement, will level the playing field for workers and businesses alike.”


Unemployment insurance and educational opportunities should be used to address employment

“There are many ways to keep more Americans in the labour market when they fall on hard times. These include providing wage insurance for workers who cannot get a new job that pays as much as their old one. Increasing access to high-quality community colleges, proven job-training models and help finding new jobs would assist. So would making unemployment insurance available to more workers.”


Post-crisis reforms have made the the US financial system more stable

“There should no longer be any doubt that a free market only thrives when there are rules to guard against systemic failure and ensure fair competition. Post-crisis reforms to Wall Street have made our financial system more stable and supportive of long-term growth, including more capital for American banks, less reliance on short-term funding, and better oversight for a range of institutions and markets. Big American financial institutions no longer get the type of easier funding they got before—evidence that the market increasingly understands that they are no longer “too big to fail”. And we created a first-of-its-kind watchdog—the Consumer Financial Protection Bureau—to hold financial institutions accountable”


As evidenced by today’s interest rates, monetary policy alone should not bear the burden for boosting productivity

“With today’s low interest rates, fiscal policy must play a bigger role in combating future downturns; monetary policy should not bear the full burden of stabilising our economy. Unfortunately, good economics can be overridden by bad politics.”


Fiscal policy has been blocked these last four years by Congress

“My administration secured much more fiscal expansion than many appreciated in recovering from our crisis—more than a dozen bills provided $1.4 trillion in economic support from 2009 to 2012—but fighting Congress for each commonsense measure expended substantial energy. I did not get some of the expansions I sought and Congress forced austerity on the economy prematurely by threatening a historic debt default. My successors should not have to fight for emergency measures in a time of need. Instead, support for the hardest-hit families and the economy, like unemployment insurance, should rise automatically.”

Capacity Utilization and Unemployment

As an addition to the previous post about how GDP is lagging potential GDP, it’s worth pointing out that unemployment is the major driver of the gap.  Below is a chart which plots the employment rate (inverse of the unemployment rate) against the potential GDP gap.  Also included is capacity utilization data, which is compiled by the Fed and is also still below its peak from the last cycle.  Capacity utilization has been trending lower for decades.

How Fast Should We Expect Unemployment to Decline?

To go along with the previous post forecasting when a 6.5% unemployment rate could occur, below is some analysis on how fast unemployment typically drops when we are in a period of falling unemployment.  Since 1949 there have been 10 periods of falling unemployment.  On average the unemployment rate falls by about 7 bps per month when it is declining.

Although the “scariest jobs chart ever” which has made the rounds on the internet implies that unemployment is falling at a much slower pace than it has in past cycles, in reality, we’re basically in line with the average rate of decline (the unemployment rate just spiked from a lower base than it had in the past.)

Unemployment Rate of Decline

When Will Unemployment Hit 6.5%?

As part of today’s statement, the Fed acknowledged that it would be maintaining the current QE rate until unemployment hits 6.5% or inflation gets out of hand (paraphrase).  Below is an estimate of when unemployment could hit that level based on an extrapolation of the current pace of decline.  Since peaking in late 2009 at 10%, the unemployment rate has fallen on average at about 6 basis points per month (.06%).  If it continues at this pace, the unemployment rate would hit 6.5% in mid 2014.

[Note that the decline has not materially picked up much pace in 2012.  In 2012 the rate declined by an average of 7bps per month.  At this pace 6.5% would occur just a few months earlier in 2014.]
Unemployment Forecast

Financial Sector Employment

Bank of America announced that it would cut 16,000 more jobs today in order to continue to cut costs amid a weak environment for financial services businesses.  The announcement adds to the continued attrition of financial sector jobs: since 2006, the financial sector has lost a total of 600k jobs.

Below is a long term chart of US employment in the financial sector.  As a percentage of total workforce, financial services actually peaked in 1986 at 6.27%.

Financial Services Jobs

Nonfarm Payrolls Relationship to Jobless Claims

On Friday, we’ll get the monthly employment report, which is expected to show an increase of 130k non-farm payrolls.  Even though the broad employment report comes out once per month, each Thursday we get a glimpse of what the employment situation looks like from initial jobless claims.  Initial claims reports can often move the market, but how good is the initial claims data at predicting payrolls?

Below is a regression of the 4-week trailing average of initial claims against the monthly payrolls data.  The r-squared of the simple linear regression is .54–not a perfect correlation, but relatively meaningful.

Recently, the 4-week average of initial claims has risen somewhat, back to 370k.  From the regression 370k initial claims would imply somewhere around a 55k increase in non-farm payrolls.  This would be well short of estimates.

What Percentage of the US Population Works?

Below is a chart of the employment/population ratio for the US.  It measures the percent of the population in the US that is working.  Even though the unemployment rate is 8.2%, that only measures those looking for work who can’t find jobs.  The number below takes into account the whole population.  At 58% of the population employed, the number is the lowest it’s been since 1984.  The employment ratio for men is near an all time low set in 2010.

Still, compared to some other developed countries the percentage of the US population that is working is relatively high.  In Italy, less than half the population is employed.