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The unemployment gap: bigger than you think

By Joe McClintock

March 1, 2012, 3:13 pm

Lately, economic commentators and pundits have decided that the generally accepted Bureau of Labor Statistics’s unemployment rate statistics aren’t good enough. Instead, they focus on U-6 unemployment, which includes marginally attached workers and workers who are working part time for economic reasons, which currently sits at 15.1 percent.

Now, clearly some people are doing this for political reasons, since Obama looks a lot worse when unemployment is at 15.1 percent instead of 8.3 percent. But this sidesteps an important debate about which is actually the more accurate metric of unemployment. It’s important to measure all of the economic suffering that is occurring due to the recession and the slow recovery, and to do so, we must consider the suffering of marginalized and underemployed workers.

However, if we are to focus on these alternative measures, we need to make sure that we are presenting these numbers in an honest and clear way. Just like it would be illogical to switch to the metric system and then give someone a speeding ticket for going 100 kph in a 65 mph zone, it is academically dishonest to claim that unemployment is at 15.1 percent without giving context for those numbers.

When looking at the U-3 unemployment rate, we consider its level in comparison to the natural rate of unemployment, generally referred to as the unemployment gap. According to Congressional Budget Office estimations, the natural rate of unemployment is around 5.4 percent, meaning that, according to the U-3 unemployment rate, 2.9 percent of workers actively looking for work are cyclically unemployed.

Source: FRED Database, St. Louis Federal Reserve.

However, the CBO doesn’t make estimates of the natural rate of unemployment based on the extended U-6 rate of unemployment. My best estimate of the natural rate of unemployment, based on the U-6 definition of unemployment, is the average of the U-6 rate since the BLS first published data in 1994. The average is 10.3, putting the unemployment gap based on U-6 at around 5 percent.

Source: FRED Database, St. Louis Federal Reserve.

These estimates aren’t a perfect measure of the natural rate of unemployment, but they do communicate an important message. It’s not enough to look at unemployment in a vacuum; we must consider the unemployment gap as the best measure of economic distress. Also, it’s clear that the practice of using statistics to confuse and mislead people is far from dead.

Joe McClintock is an intern with the economics department at AEI.

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Ben Bernanke, backed in a corner

By Joe McClintock

February 22, 2012, 10:13 am

Ben Bernanke, the chairman of the Federal Reserve, has been having a rough time lately. He’s received criticism from politicians, pundits, and other central bankers, and has been attacked for doing both too much and too little. The actions of the Federal Reserve have not received this much scrutiny in a long time, undoubtedly due to the rising scope of their actions and the heightened sense of urgency surrounding them.

I don’t wish to discuss the legitimacy of the Fed’s past actions. Instead, I want to discuss the actions they will have to take in the next few years. As the economy begins to tentatively recover, the Fed must walk the thin line between encouraging growth and causing uncontrollable inflation. And as Bernanke’s critics reveal, there are arguments for doing more to address both issues.

For inflation hawks, images like this are seriously frightening:

Such a dramatic increase in money supply would lead to dangerous inflation during any normal economic time. However, these are not normal economic times, and expanding the money supply cannot cause inflation while demand is suppressed. So, while the Fed should keep an eye on inflation as the economy recovers, there has been little evidence that rising inflation will warrant action in the short term.

On the other hand, the weak economy still has far to go before it is fully recovered. Improvements in employment and output are good news, but aren’t enough to bring a rapid recovery. More importantly, the lingering weakness stems from a lack of demand, which the Fed is ill-suited to address. Like the proverbial dehydrated horse, it can’t force the markets to expand growth, and further expansionary policies would only serve to feed inflationary pressures when the markets do recover.

So what can Bernanke and the Fed do? I would suggest the simple task of waiting, and making sure not to make promises they aren’t prepared to keep. While a reasoned resolution of Europe’s debt crisis, or a similar solution to our own debt situation, would be helpful, there is little Bernanke can do other than make speeches. He would be best off to let monetary policy be, and prepare a response to rising inflation or a Europe-related confidence crisis; problems that the Fed is well suited to deal with.

Joe McClintock is an intern with the economics department at AEI.

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The Fed: The new Supreme Court?

By Joe McClintock

February 16, 2012, 5:43 pm

The Supreme Court was designed to be politically independent, with justices appointed to life terms and removed only in cases of great indiscretion. However, since the Senate’s rejection of Robert Bork, Reagan’s nominee for the Supreme Court in 1982, scholars of political science have recognized that the Supreme Court is far more politicized than its independent nature implies. Confirmation battles are fought on party lines, citizens protest rulings with the same furor as they protest bills from Congress, and justices and the decisions they hand down are more politicized than ever.

This divisiveness has developed over a quarter century, yet we can see similar developments in another semi-independent agency whose decisions have large impacts on Americans: The Federal Reserve. The comparisons between these two institutions reveal both similarities and differences. Like the Supreme Court, the Federal Open Market Committee (FOMC) is a small group of elites whose decisions have a great impact on the United States. Though FOMC members do not enjoy lifetime appointments, they are largely independent, with seven of the twelve members appointed, similarly to the Supreme Court, and five of the twelve chosen by banks, with no citizen input.

The Fed had its Bork moment last summer with Peter Diamond, a decorated economist whose nomination to the FOMC was blocked by Republicans for ideological reasons. This came amidst many calls to audit, or even eliminate, the Fed, led initially by Texas Congressman Ron Paul but later adopted by many Republicans. Strong criticism of the Fed’s Chairman, Ben Bernanke, have also featured prominently in the 2012 Republican primaries, with most candidates calling for his resignation or arguing for changes to the Fed’s statutory mandate.

So, how does this bode for the Federal Reserve? It is unclear. Criticism of the Fed will likely wane as the economy recovers and its expansionary policies are scaled back and forgotten. In the meantime, attacks on the Fed’s independence are dangerous, since, like the Supreme Court, independence is crucial to its operations. Calls for audits and greater transparency are less concerning, and the Fed has already adopted many of these programs; changes to the statutory mandate are very concerning.

So, yes, the Fed will doubtlessly face greater scrutiny and criticism in the future, but Bernanke seems to have addressed these attacks well. On the small things, he has made concessions; on the big things, he has defended the Fed’s independence. Hopefully his inevitable replacement will be similarly dedicated to keeping the Fed independent.

Joe McClintock is an intern with the economics department at AEI.

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The paradox of disillusioned young voters

By Joe McClintock

February 10, 2012, 2:45 pm

Michael Barone recently wrote a piece discussing the Republicans’—or, at least, the mainstream Republican candidates’—failure to address the youth vote. In particular, he mentions how the Republicans’ mantra of “choices and opportunities” should appeal to young voters who “want to shape their own destinies, not be part of a herd that is shepherded from one pasture to another.” But despite this hypothetical source of appeal, the recent primaries have failed to draw the youth vote, and those that did vote largely supported the outsider, Ron Paul, over the established candidates. This raises the question: Why has the Republican Party failed to appeal to young people?

Some may blame it on liberal bias in schools. While I can speak from experience that this may be partially true, these patronizing views underestimate young people’s ability to see through liberal bias, especially in the age of the internet. Instead, there must be something about the Republican Party that repels the youth vote. Though I can’t speak for youth in general, I can sum up my and some of my colleagues’ objections in a single word: Hypocrisy.

The hypocrisy that I am discussing is the inherent contradiction between the Republicans’ small government fiscal policy stance and their statist, big government approach to social policy. It seems misguided to argue for choice when it comes to healthcare but argue against it when it comes to birth control, as Rick Santorum has. It seems contradictory to argue for limited government when it comes to taxes but then advocate for strengthening the Patriot Act, as Newt Gingrich has. And it is hypocritical to argue for liberty when it comes to the markets, but deny the freedom to marry to an entire class of people based on sexuality, as Mitt Romney has.

This intellectual contradiction was the basis, or at least should have been the basis, for the debate held at AEI last night. As both Jonah Goldberg and Matt Welch explained, fiscal conservatism is a powerful message at a time when we are facing an unprecedented debt crisis. However, it’s a mistake to dismiss these social issues as unimportant, as they did, because social issues hold a powerful emotional sway with voters, even if their consequences are far less devastating than those of the debt crisis.

So my answer to Michael Barone is that if Republicans want to appeal to youth voters, drop the hypocritical, patronizing social policies. I’m not saying we should support Ron Paul (his views on The Fed and the gold standard would undermine our economy worse than the debt crisis). But if Republicans want to appeal to young people—and Independents in general—leave the social issues for society to sort out and focus on the message that actually has appeal: addressing the debt and fixing the economy.

Joe McClintock is an intern with the Economics Department at AEI.

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