Weekly Initial Claims for Unemployment Insurance: A Good Report, But Not Yet Where It Needs to Be

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Initial claims for unemployment insurance continue to improve, although claims are still somewhat above where they would normally be when the economy is at full employment.  While there is a good deal of noise in the week to week figures, the trend has clearly been an improving one.  But there are concerns that weak US growth, and problems stemming from Europe and elsewhere, could undermine the improvement seen so far.

The data come from this morning’s regular weekly release by the US Department of Labor, and it is helpful to see the figures in the longer term context.  The graph above updates one from my posting of November 20, 2011.  Initial claims for unemployment insurance came to 348,000 in the week ending February 11, far better than the roughly 650,000 per week who were being laid off and filing claims for unemployment insurance when Obama took office.

The initial unemployment claims are still somewhat above, although now fairly close to, the level of around 310,000 to 320,000 per week that one would see when the economy is at close to full employment.  As was discussed in a January 19 posting on this blog on the dynamics of the labor market, there is constant churning in the jobs market, with workers being laid off even when the economy is at full employment.  And as was shown in the second graph in that January 19 posting, layoffs are now close to where they were before the 2008 economic collapse.

But new hires remain (at around 4 million per month) well below where they would be when the economy is operating at full employment (around 5 million per month).  Hence unemployment remains high (8.3%).  Firms have a surfeit of cash in their accounts from very high profits (see posting here), but there is little demand for extra production.  Unfortunately, it is now politically impossible (due to concerted Republican opposition in Congress) for the government to follow the expansionary policy one would need to provide that demand.

So the economy continues to grow, but slowly.  Hence the employment situation has continued to improve, but only slowly.  And there are concerns that the on-going recovery in 2012 remains fragile.  As was noted in a January 27 post, US growth in the fourth quarter of 2011 was largely due to a large increase in inventories.  This is unlikely to continue, and even if inventory growth increases again as much as it did in the fourth quarter (with all else growing as it did in the fourth quarter, although these will of course change), GDP growth would come to only 0.8% at an annual rate.

There are also major concerns arising from Europe.  Europe has been following deliberate austerity policies, and consequently is likely now in recession.  It was announced yesterday that GDP fell in the EU as a whole at a 1.2% annualized rate in the fourth quarter (0.3% at a quarterly rate).  The normal criterion for a recession is for two quarters of such negative growth.  The Greek crisis is also not resolved, and could get much worse.  And there are other global concerns as well, such as the risk that tensions with Iran could escalate and lead to an attempt to close of the Straits of Hormuz, and cause oil prices to skyrocket.

So while the labor market has improved, there are concerns on whether this can be sustained.

Resolving the US Fiscal Deficit: Understanding the Causes, and What to Do Now

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The US came close to defaulting on its public debt in August 2011, when Congressional Republicans refused to raise the debt ceiling unless their demands were met.  And the public discussion and what was presented in the press accepted the view that to bring the US budget dynamics back to a sustainable path would require drastic cut-backs in federal expenditures.  Of necessity, it was said, this would have to include drastic cut-backs in important social support programs, which would devastate the lives of many who were struggling to get by.  Not surprisingly given these presumptions, the deficit and debt issues are still not resolved.

Actually, the issue is not that difficult, at least for the next decade.  While there will, indeed, be long term problems that need to be addressed in the US budget dynamics, these will not arise until the 2020s and 2030s.  They will stem at that time from rising medical costs coupled with an aging population, and will need to be addressed by health system reform (which the Obama reforms start to address, but do not go far enough).  But as will be shown below, the issue through at least 2022 would be fully addressed provided one allows the Bush tax cuts to be phased out (and under current law, they are due to expire), leading us back to tax rates under which the economy performed quite well during the Clinton years.

One first needs to understand what led to the current budgetary problems, problems which (due to Congressional brinkmanship) almost led to the US Government defaulting on its debt last summer.  One can then work out alternative scenarios for the fiscal accounts, to examine “what if” questions to see the impacts of certain policy decisions.  These are worked out below, using numbers made available by the Congressional Budget Office, in its recent, January 31, 2012, report titled “The Budget and Economic Outlook:  Fiscal Years 2012 to 2022”.  The calculations were somewhat complex to work out (it is especially important to include the feedback from higher or lower fiscal deficits on the future interest payments then due on the resulting debt; many analysts ignore this).  But I was then surprised by how quickly the fiscal accounts would stabilize provided only that the Bush tax cuts were phased out.  Not more is needed.

We can start with the fiscal accounts based on the historic actuals between fiscal years 1972 and 2011, and then (for 2012 to 2022) as projected by the CBO under its current policy scenario.  The current policy scenario (which the CBO calls its “Alternative Fiscal Scenario”) assumes that the Bush tax cuts will be renewed and that the “automatic” spending reductions mandated under last year’s Budget Control Act will not in fact happen (and also that compensation of doctors under Medicare is kept as now rather than being cut:  but this is minor).  The resulting fiscal accounts look like this:

One sees here the deterioration in the accounts during the Reagan presidency, as revenues were cut (the Reagan tax cuts) and outlays were increased (defense expenditures) leading the public debt to GDP ratio to almost double during the Reagan and Bush I years, from 26% in 1981 to almost 50% in 1993.  Outlays were then reduced and revenues increased during the Clinton years, reducing the deficit and in fact leading to a surplus by 1998.  The public debt to GDP ratio fell sharply.  Bush II then cut taxes sharply soon after taking office in 2001 and increased outlays, leading back to deficits, and the public debt to GDP ratio started to rise again.

Revenues then fell sharply in 2008 and especially in 2009 as a result of the 2008 economic collapse as well as tax cuts aimed at stimulating the economy.  Outlays rose in the downturn to cover increased expenditures on unemployment compensation and similar support programs, as well as a consequence of the Obama stimulus measures enacted in response to the sharpest downturn the US had faced since the Great Depression.  Under the CBO projections going forward, outlays are expected to remain well above revenues, leading only to a gradual fall in the deficit.  The public debt to GDP ratio then explodes, reaching 94% of GDP in 2022 and still rising.

This scenario is pretty grim and is clearly not sustainable.  Hence the agreement by all that something needs to be done.  But first it is important to see why the fiscal situation deteriorated so much since 2001, when Bush II took office.  There were two main reasons:  the Bush tax cuts, and the decision to fight major and lengthy wars in Iraq and Afghanistan without taking any step whatsoever to pay for them other than through borrowing.

Of these two, the Bush tax cuts are the more important.  The CBO estimates that the Bush tax cuts will lead to reductions in collected tax revenues of about 2.5% of GDP each year going forward (up to 2020 when the losses are projected to rise a bit to 2.6%, and then to 2.7% of GDP in 2021 and 2022).  Over a twenty year period, and considering also the resulting higher public debt and hence the interest due on this higher debt, this is huge.

The unfinanced wars in Iraq and Afghanistan have also been costly.  Based on CBO estimates, the wars have cost on average 1.0% of GDP each year between 2003 and 2011, and will decline only modestly in 2012 and 2013.

Using the CBO data, one can then calculate what the fiscal picture would have been, and what it would then be expected to be, had the Bush tax cuts never been passed, and had the Iraq and Afghan wars not been started (or, in terms of the impact on the deficit and the debt, had they been paid for by current taxes rather than borrowing).  Under this scenario the budget is in surplus and debt falls rapidly until the shock of the 2008 crisis.  And the deficit and the debt then stabilize quickly after that shock:


Note the scale here is different from that in the figure above.  With just these two changes, and leaving all else as before (including the economic collapse of 2008, even though some have argued it would not have then been so severe), the fiscal deficit diminishes and becomes a surplus by 2020, and the public debt to GDP ratio levels off and then starts to fall by 2014/15.  (Note for those not familiar with such dynamics:  The debt to GDP ratio can fall even while the public accounts are in a modest deficit because of GDP growth, which increases the denominator in the debt to GDP ratio.)  The public debt to GDP ratio peaks at 35% of GDP, well below what it reached during the Reagan / Bush I period.

Putting the two scenarios together on one figure allows for easier comparison:

All is the same until 2001, so this focusses only on 2001 to the projected 2022.  Revenues are always substantially lower as a result of the Bush tax cuts.  Outlays are always higher, for two reasons:  the costs of the Iraq and Afghan wars, and then, growing over time, due to outlays for interest on a growing public debt as a result of the deficits.  Deficits are always substantially higher with the Bush tax cuts and wars, and worsen over time due to growing interest expenditures.

And the impact on the public debt to GDP ratios is particularly stark:

The cause of the fiscal mess we are in is therefore clear:  without the Bush tax cuts and the unfinanced Iraq and Afghan wars, the fiscal accounts would not have worsened so much in the 2008 economic collapse, and would soon be back on a sustainable path.  This is taking all else as equal, including all other revenues and expenditures, as well as overall economic growth.  While it is certainly fair to note that all else would likely not then have been equal, there is no evidence to support the Republican argument that higher taxes (without the Bush tax cuts) would have stifled economic growth.  Without the Bush tax cuts, one would have had tax rates as they were during the Clinton years, when the economy grew well.  Why would taxes have suddenly become such a problem?  And growth during the Bush years was in fact quite poor (and terrible if one measures it by growth over his two full terms, with the 2008 collapse at the end of his second term).  The lower taxes under the Bush tax cuts did not lead to better growth than what the US economy achieved during the Clinton years.  It was far worse.

It is also fair to note that while the above may help us understand better the causes of the current fiscal mess, it does not by itself tell us how to solve the mess.  We cannot change the past.  But it does point out that re-establishing prior tax rates would be a clear place to start.  And it turns out that by themselves they would be more than enough:

This scenario assumes that the Bush tax cuts will be phased out starting in 2014 (and not earlier, as the economy has not yet fully recovered from the 2008 economic collapse), with 50% phased out in 2014 and 100% phased out from 2015 and onwards.  This, by itself, puts the economy on a stable and sustainable fiscal path.  The public debt to GDP ratio peaks in 2014 and then starts to fall, and the fiscal deficit falls steadily if slowly, to just 1% of GDP by 2021.  Revenues stabilize at about 21% of GDP and outlays at 22% of GDP.

In summary, the Bush tax cuts enacted in 2001 and 2003 (and extended in 2010 for two further years, through 2012), plus the costs of the unfinanced Iraq and Afghan wars, have undermined the US fiscal accounts, to the extent they are now unstable and lead to explosive growth in debt.  Had these decisions not been taken, the fiscal accounts would be quite stable, even with the extraordinary measures that were necessary (and the decline in fiscal revenues received) due to the economic collapse of 2008 and the then slow recovery.  But even with the debts incurred due to the Bush tax cuts and his unfinanced wars, the fiscal accounts can be put on a sustainable path simply by phasing out the tax cuts starting in 2014.

Employment Growth in January: Better, but Sustainability is a Concern

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The employment report for January, released this morning by the Bureau of Labor Statistics, is a positive report.  But while employment growth is now improving, it is still not rapid enough, and its sustainability is a concern.

As I had noted in a posting on December 5 in this blog, monthly employment growth in the US needs to be in a range of roughly 200 to 250,000 per month for unemployment to fall on a sustainable basis.  One is now starting to see that, with overall employment growth of 203,000 in December and 243,000 in January.  With such growth, the unemployment rate fell from 8.9% in October to 8.7% in November to 8.5% in December and to 8.3% in January.  This is certainly welcome.  But unemployment at 8.3% is still far too high.  In a more robust recovery, one would be seeing monthly employment growth figures of over 300,000.

And the overall employment figures are still being held back by falling employment in government (mostly state and local government, which accounts for 87% of government employment in the US, but there have also been falls in federal employment).  In January, total government employment fell by 14,000, thus partly offsetting the rise in private employment of 257,000, to produce the overall gain of 243,000.

For the past year (January 2011 to January 2012), government employment fell by 276,000.  This has been a significant factor in holding down overall employment growth.  And government employment fell by 230,000 in the year before that (January 2010 to January 2011), and fell by 97,000 in the year before that (January 2009, when Obama was inaugurated, to January 2010), for a total fall in government employment of 603,000 over the three years.  In the three years before Obama took office, government employment rose by 248,000 in 2006, rose by 281,000 in 2007, and rose by 200,000 in 2008, for a total increase of 729,000.

Yet Obama has been repeatedly accused of creating an explosion of government.  (For a more detailed review of what has happened to Federal Government employment alone, see this blog.)  Had total government employment risen by 600,000 rather than fallen by 600,000 since Obama took office, one would have had an extra 1.2 million jobs directly.  Even ignoring any multiplier impact, this by itself would have led to an unemployment rate now of 7.5% rather than 8.3%.  And assuming, conservatively, a multiplier of just two (so that one additional government job leads to one additional private job, to supply the goods to cover the increased personal spending of the now employed government workers), the unemployment rate would now be a more respectable 6.7%.

While the January employment report was positive, one should keep in mind that there are threats on the horizon.  Two to consider:

1)  As noted in a January 27 blog, GDP growth in the fourth quarter of 2011 was only 2.8%, and 70% of this came from the change in the change in private inventories.  Without this inventory change, GDP would have grown by just 0.8%.  For the first quarter of 2012, it is unlikely that private inventories will again go up by so much.  And note that because it is the change in the change in private inventories that is the contribution to GDP growth (see this blog), then should private inventories once again increase by as much as they did in the fourth quarter of 2011, the growth in GDP in the current quarter would only be 0.8% (everything else being equal as in the fourth quarter of 2011, which of course it won’t be).  That is, inventories would have to continue to rise by as much as they did in the fourth quarter of 2011 simply to keep GDP growth at 0.8%.  They are likely to rise by far less, and quite possibly might fall if the high level of inventory accumulation in late 2011 was more than suppliers wanted.  This could then significantly hold back production and GDP growth, and hence employment growth, over the next several months.

2)  Europe continues to be problematic, with the focus on policies (fiscal austerity) which will make the situation worse rather than better.  Europe will certainly be in recession in 2012, and probably already is, and this will hurt the US recovery.

And there are of course other risks, such as, for example, an escalation in tensions with Iran leading to disruption of shipping through the Strait of Hormuz, that could cause oil prices to skyrocket.  There are many such scenarios that one can imagine, so a US recovery is anything but certain.  So while the January employment report was a positive one, there are still reasons to be concerned.