Wednesday, February 16, 2011

US normal rate of unemployment

In another story about a post-GFC “new normal”, the good folk at the Federal Reserve Bank of San Francisco (FRBSF) have done a bit of thinking about the new “normal” rate of unemployment in the US.

In more technical terms, this is what economists call the NAIRU or “non-accelerating inflation rate of unemployment”. This is the rate of unemployment, give or take a bit, that the Federal Reserve Board would see as being consistent with the part of its mandate relating to full employment. In the pre-GFC world, the natural rate of unemployment was thought to be around 5%.

The FRBSF research suggests the current normal rate of unemployment in the US is around 6.7%. That sounds reasonable to us. They also attribute some (half) of the rise to the extension of unemployment welfare payments. Not sure about that bit, especially the quantum.

It seems sensible that the normal rate of unemployment is now higher than it was pre-GFC. We are strong believers in the structural nature of the recession in the US (and just about every other country for that matter).

In the US, large numbers of people have lost their jobs in sectors such as finance, real estate, residential construction and retailing. That’s not where the new jobs will be, at least not in the short term. The new jobs need to be in export oriented manufacturing sector. There is clearly a skills mis-match between the newly unemployed and the new jobs. That will take time to fix.

That’s why we warned early on in the recovery that at least some of the excess capacity in the global economy could actually turn out to be redundant, or at least not easily deployed in the new world. The upshot of that is lower potential GDP growth as capacity constraints get hit earlier on in the cycle.

This will be most obvious in the labour market with skills shortages likely to emerge while unemployment remains elevated, or at least at a higher rate than we previously thought consistent with full employment.

It’s interesting that the Federal Reserve, in its decisions to go ahead with QE2, discounted this argument to some extent, believing that the current high unemployment rate in the US is largely cyclical. Time will tell.