Unemployment Insurance Claims and the Unemployment Rate

Scott Sumner wonders why layoffs are so low.  Here's a messier version of his graph:

The blue line is the ratio of initial claims to the labor force.  In the past, with claims levels this low, unemployment would have been down to 4% or 5%.

Continued claims (red line) aren't quite as low, but even they would point to 5-6% unemployment (the green line +2).

The orange line is the ratio of continuing claims to initial claims.  This ratio appears to have a significant upward slope over the past 50 years.  This is the result of an economy with less employment churn and/or longer average duration of unemployment.  This trend is over a long enough time period that age demographics is probably not the explanation.  There must be some political or cultural trend that is creating a less volatile labor market.

Extended unemployment insurance is not included in the continued claims measure.  There are currently about 2.8 million unemployed workers with continued claims, or about 1.8% of the labor force.  There are an additional 1.35 million workers on extended UI benefits, or about .9% of the labor force.

Adding the extended unemployment insurance numbers to the normal continued claims would move the continued claims series up to about 2.7% of the labor force, tracking right alongside the unemployment rate series.

Continuing claims are declining, but are starting to level out.  On the other hand, extended UI rolls are shedding about 800,000 workers per year with a pretty linear trend.  This, combined with the probability that Congress will shut down the program as the economy recovers, means that we should see the unemployment rate tracking with normal continued claims by around the end of 2014 or beginning of 2015, which would put UE at about 5% or 6% soon after, if continued claims are still declining slowly.

This suggests that there are some tailwinds for the unemployment rate, and we could see it continue to fall at a rate at least as fast as the recent trends.

Recent work by Farber and Valletta suggests (pdf), only pegged about .4% of the peak unemployment on EUI.  But, they found that most of the added unemployment duration associated with EUI was the product of delayed exits from the labor force, not from delayed re-entries into the labor force.  So, a winding down of EUI could lead to a reduction of a few tenths of a percent in the unemployment rate, even without any new resurgence in employment.

Normally, I have been arguing that the recent declines in the Labor Force Participation Rate are all demographic.  This is a slight counter to that argument.  EUI is probably causing LFP to be overstated by a few tenths of a percent.  Without the EUI effect, LFP would probably be showing some additional cyclical weakness, even when demographics are properly accounted for.

Another complication with EUI is that duration-based measures can estimate it's effect on transition rates, but an EUI policy could cause more unemployed workers to reach the end of normal UI and could even cause more initial unemployment claims.  Cross-state comparisons might shed some light on this possibility.  In June, North Carolina made an abrupt cut in EUI.  As the graph here shows, North Carolina initial claims (blue, NSA) immediately declined precipitously, which is a little bit surprising.  I have added some national numbers (green (SA) & yellow (NSA)) to the graph, also.  This confounds the natural experiment, because there happened to be a national decline at the same time, although not as deep as the one in North Carolina.  It is too soon to read too much into this, though.

I have found that rates of exit from unemployment at both long and short durations have been high during this recession.  If a portion of even initial claims and exit rates of recent unemployed workers is also related to EUI, the effect of EUI on unemployment would have to be revised upward.

The good news is that the continued declines in EUI claims and the recent sharp improvements in regular unemployment insurance claims both presage a continued decline in the unemployment rate.

More on lifecycle effects on income inequality

I wanted to revisit this post from the other day.  It included this graph, and I am adding the graph below for further analysis.

On both graphs, I should point out that the Census Bureau data I am using combines all incomes over $100,000, so I have cut off the x-axis at that level.

The point of the first graph was to show how the income distribution within a working-age age group is much more symmetrical than the aggregate, and that the hump of low income households is a product of lifecycle effects.

The second graph here clarifies that point.

This creates a bit of a paradox, because the aggregate income numbers are combining several pools of households with very differently shaped distributions, so the median household income at any given time is inflated by lifecycle effects, which makes the income distribution appear to be more uniform than it is, but the skewed shape of the aggregate distribution and other statistical forms of income inequality will be overstated.

First, on the overstated inequality, the second graph shows the difference in the distribution of incomes between the 15-24 and 65+ age groups and the 40-44 age group.  We can see from this graph how the hump in the aggregate income distribution comes from the young and old age groups.

So, the position of the mode income level below $20,000 in the aggregate income distribution is not a product of an oversized underclass of working families.  It is the product of very young and very old households which we do not expect to have income.  In this data from 2007, roughly 47% of the bottom quintile and 36% of the 2nd quintile of households stem from generally non-working or lightly working households from the 15-24 and 65+ age groups.

Now, I absolutely don't want to make light of poverty.  But, statistics about the incomes of the bottom third of the income distribution tell us nothing about poverty among households that we expect to have incomes.  In order to discuss actual levels of poverty, we need to account for this distortion.  Especially in the years ahead, as the 65+ age group grows, the bottom quintile of households will be more and more populated with households that aren't poor.

This third graph helps to visualize this and also might help to visualize why the aggregate median income becomes inflated by lifecycle effects.  We can imagine counting up to about $50,000 to get to the median household.  At that level of income, the head of household is very likely to be between 25 and 65 years old, working full time.  During the year they are measured as the median household, they are very likely to be making more than their average lifetime income, because that average will be brought down by some years when they are very young or very old when they are not working and have very low incomes.  In other words, if that median family could have smoothed their income over their lifetime, they would probably be making less income during the year when they represent the aggregate median household.

Austerity in recessions

Menzie Chinn has a post on austerity in the latest recession.  Here is the graph:

This shows a correlation between economies that increased their structural government budget deficits and economies that recovered from the recession.  In other words, increased spending or tax cuts help economies recover.  He included a link to his data source, so I played around with it to see what I could find.

Here is my first graph.  I used OECD countries, which I think differs slightly from his grouping, and my scale on the y-axis is average annual real GDP growth, where I think his is the total over 4 years.  But, it looks to me like we basically have the same data and the same general correlation:

But, in the end, I find that the causal factors are probably the initial expenditure levels and structural balance.

Savings, Investment, Unemployment, and Federal Deficits

The New Arthurian posted some interesting relationships from Fred:

Savings/Investment compared to Unemployment and Investment minus savings compared to the federal deficit.

http://newarthurianeconomics.blogspot.com/2013/09/saving-and-investment.html

It will be interesting to see how these behave through the next cycle.

Skewness in lifecycle income

Well, I thought I would try to estimate the amount of income inequality that is due to life-cycle effects.  I made the assumption that within each age group, all incomes were equal (at the age group mean), and then estimated the median income of the total population.  I was surprised to find that the age-egalitarian median income was higher than the mean income:

I had assumed that income distribution was always positively skewed.  But, what this shows is that typical lifecycle income is negatively skewed.  In other words, there are many years in a typical lifetime where income is a little bit higher than the lifetime average, and there are few years where income is significantly below the average.  In fact, it is a two-humped distribution, with a large hump of years from about 25 to 65 with above average income, and another smaller hump with very little income during the other years.

As schooling extends farther into the 20's, long retirement becomes more common, and the number of older Americans grows, the negative lifecycle skew should become less pronounced, so this will cause the statistical aggregate mean income to look excessively stagnant compared to past median income.  But, there are at least two other interesting factors here:

1) Since lifecycle income skews negative, this actually normally makes the median income appear higher than it would without the effect of lifecycle income changes.  This factor probably inflated statistical median income growth in the 1990's.  One way to think about this is that, at any given time, the median income household for that period of time is probably making an income higher than their lifetime average income.  So, for instance, when the baby boomers were middle aged in the 1990's, at their peak earning years, this factor was especially causing the median income to be elevated, because more households were near their peak lifetime income level.

In this graph, the green line is a measure of how much the negative skew of lifecycle earnings inflates the median income.  This has flattened, and should start decreasing as baby boomers age into retirement, which will cause the measured median to decline.  The red line is the ratio of the mean income to the median income, which is a rough measure of the positive skew of incomes.  The blue line is the ratio of the mean income to the median income adjusted for the negative lifecycle skew.  After adjusting for the increasing negative lifecycle skew, this shows past income inequality increasing even more, once changes in the lifecycle adjustment are included.

2) The non-normal distribution of incomes over a typical household's lifetime might create a false picture of a two-tiered economy.  Middle class households would register many years at roughly half their lifetime average incomes, and even more years with incomes higher than average.  But, they would not register very many years with incomes between 50% and 100% of their lifetime average income.  In order to create a clear picture of lower income families, adjustments would have to be made to account for middle or upper class households with lumpy income and consumption smoothing.  Unadjusted measures of the bottom 2 quartiles of household income will tell us very little about the true state of households with low lifetime incomes.

We can get a sense of this error by viewing the income range of a single age group:

This is from 2007 detailed census data.  The data for the total population appears to have a large mass of very low income households.  But, we can see by isolating the 35-44 year old age group that this is mostly a product of households at other age levels who will mostly be earning above average incomes when they are 35-44, and are taking advantage of the extra wealth to extend schooling or retirement during other years.  In fact, we should expect that households with lower lifetime incomes will be more likely to be working in their 20's and 60's, so they will not be populating that low income hump in the blue line.  They will have less lumpy lifetime income and will probably be earning incomes much closer to their average lifetime incomes during those years.

Wealth, ironically, causes a statistical anomaly that shows phantom poverty.

I propose that the distribution of 35-44 year olds here is much closer to the distribution we should be referencing when considering the number of households in poverty relative to the whole population.

PS.  I saw a paper somewhere recently, I think, that discussed the negative skew of lifecycle income, but I can't remember where I saw it.  Please let me know in the comments, if anyone knows of it.  Also, please comment if any of the statistical inferences here seem way off base.

Why I like NGDP over inflation targeting

Vince Foster has another intriguing post about Fed policy.  It's another one where we come to the same conclusion, but with different priors.  He is worried that the Fed will be too hawkish about pulling back on QE and cut off the legs of the recovery.  I agree that, at this point, a hawkish error is more likely than a dovish error.

Along the way, he argues that the largest problem in 2008 was that the Fed allowed too much inflation.  I think this is a good example where thinking in terms of interest rates can get us in trouble.

There is basically a Wizard of Oz problem with the Fed.  The natural interest rate is a moving target, and in theory, if the Fed undershoots that target they cause inflation and if they overshoot it they cause deflation (or disinflation).  The problem is that everyone assumes that all rates movements are Fed-led movements.  I suspect that, at least over the last 10 years, the Fed has followed rates much more than they have led them.  This is most obvious at times like in June, where the Fed announces that they are pushing rates down to continue to bolster the economy, and seconds after the announcement, rates shoot through the roof.  This is a terrible problem, because if the Fed chases rates down, but everyone thinks they are leading rates down, we're all whistling past the graveyard.

And, this is where thinking like a market monetarist, which is the school of thought that says the Fed should target NGDP growth, can be illuminating.

Here is a messy chart of the past decade, covering the period of time with TIPS spreads:


During the period coming out of the previous recession, from 2003 to 2006, the Fed is basically tracking the natural rate.  The Fed Funds rate (pink) gradually rises into the recovery.  Real 5 year rates (red) rise gradually also while 5 year expected inflation from TIPS spreads (blue) are basically flat.  Excess unemployment (green), slowly declines, core inflation is tame (purple), commercial loans (gray) increase at a reasonable pace, and  NGDP(yellow) first shows a snap back from the recession at up to 7%, gradually declining toward 5%.

First, I want to address this notion that the Fed overheated the economy.  This assertion is based on one outcome - rising asset and home prices.  As I outline here, home prices may have actually been stoked by a Fed that was too hawkish.  And, in any case, this is a strange sort of amnesia.  This obsession about the Fed and inflation is specifically a reaction to the 1970's, yet if one thinks about the 1970's, it should seem obvious that high inflation and loose money don't necessarily correlate well with high real economic growth, real asset prices, or with real stock market gains.  There was a lot of stuff going on in the 70's (there always is), but I don't know of anyone who connects the extremely high inflation to an "overheated" economy.

But, back to the 2000's, up to 2006, all of these indicators seem very normal.  The Fed was mainly staying out of the way.  Even home prices were receding manageably in 2005 and 2006 as real interest rates climbed.

When 2007 hit, the interest rate interpretation of the Fed is that they started pushing rates down in order to stoke the economy, but inflation started to get out of control, and by the end of 2008, the housing bust, Bear Stearns, and Lehman were just too much for the economy to handle, so even when the Fed kept pushing rates down to unprecedented levels, it wasn't enough.

But, this all presupposes that the Fed is moving rates.  Let's look at this from an NGDP perspective.
Here is a closer graph:

If the Fed was leading the way, we would expect a Fed Funds rate cut to cause a rise in some combination of inflation, expected inflation, and NGDP.  Over the last half of 2007, coincident with minor cuts in the Fed Funds rate, we see steady inflation, steady expected inflation, and declining NGDP.  In addition, the unemployment rate is starting to rise.  To be sure, inflation with food and energy (orange) spikes, and commercial loans are still growing (this, though, is a lagging indicator).
But, the tricky part is the collapsing 5 year real rate.  Interest rate based views of the Fed would attribute this to a liquidity effect, due to the Fed buying bonds in open market operations (which, by the way, they weren't, although their true effect on the money supply was muddied by the other liquidity operations they were providing to prop up the frozen mortgage-backed repo markets.).  But, from an NGDP perspective, a collapsing real rate in the face of stable core and expected inflation, rising unemployment, and dropping NGDP growth is a good sign that the Fed is just chasing the rate down, and that trouble is brewing.

By summer 2008, while the Fed stubbornly held the Fed Funds rate at 2%, every indicator except the noisy inflation with energy and food measurement was heading in the wrong direction.  Even the lagging indicator, commercial loans, was decelerating.  By this time, even the rising real 5 year rate, coincident with a quickly rising unemployment rate, was probably an early sign of freezing credit markets.

The Fed didn't add liquidity to the market until QE 1 at the end of 2008.  By then, fear and low rates meant the money supply would have to be bloated to unheard of levels to effect any inflation.

We are now, again, in dangerous territory.  Since we are at the zero bound, the Fed isn't interest rate targeting, although they are still communicating through expectations of future rates.  Recent rate increases are a good sign of economic prospects, similar to the rising real rates from 2004-2006, and unemployment should continue to trend down.  But all inflation indicators are tame, and NGDP and commercial loan growth are anemic.  We are again in a situation where a reversal of real rates is probably a bad sign.  If falling real rates reflect new concerns about the economy, but they are interpreted as the result of Fed liquidity actions, we could suffer through more inappropriate hawkishness.  Either NGDP, inflation, or real rates need to continue to show strength moving forward to support confidence in a continuing steady recovery.

As does Vince, I expect a continued recovery for the time being, but there is potential for money supply mismanagement here.

Median Incomes

Some new census data is out.  Tyler Cowen has a couple of links.

As usual, there is some basic disaggregation that can provide some interesting details.

When Minimum wage becomes relevant

The effect of the minimum wage in American Samoa and the Northern Mariana Islands offers a good example of how there are two possible outcomes with minimum wages:

1) It is low enough to have such a small effect on the total labor force that measurement of outcomes is difficult.

2) It is high enough to have a measurable effect.  The workers on these islands now have experienced that effect, unfortunately.

http://online.wsj.com/article/SB10001424127887324549004579070941643960488.html#articleTabs%3Darticle

(I think non-subscribers can see the article if you google "minimum-wage realities".)

Is the economy producing too many low quality jobs?

There are a lot of stories like this and this that fret over the low quality of new jobs coming out of the recession.  The notion is that there are millions of qualified workers clamoring for work, but firms are not investing in high wage jobs.

Investment did take a big hit in the recession, but it is recovering pretty normally.  Still, the deep plunge could have caused a lingering lack of investment for high wage labor.

But, still, if firms were being slow about reinvesting, wouldn't high wage production bring more value-added than low wage production?  It seems just as likely that we should expect a dearth of low wage jobs.  Of course, in that case, we would have higher unemployment among the poor, which doesn't seem any better.

But setting labor demand aside, there is also supply.  I'm afraid that we acquiesce to the sort of vulgar Marxism of populist economics by assuming that labor markets are directed only by demand, and that workers must find a place to plug in to the fixed set of labor opportunities that firms decide to provide.  But, labor markets in the US are clearly directed by both.  Labor supply is going to look like this, with a lot of older, experienced workers leaving the workforce and a large number of twenty-somethings just getting their first serious jobs.  If labor supply were the directing force, workers might be forcing firms to develop a lot of new entry level jobs to replace a lot of senior jobs.

Looking around the world, clearly the best way to create high wage labor demand is through functioning markets.  In fact, I think we have evidence that there has been a surplus of middle wage labor demand in the US.  We know what an economy looks like where there is a shortage of labor demand.  It's the kind of economy where you get in a cab and discover that the driver has a masters degree in mechanical engineering, or where you see a guy with a little table on the sidewalk, selling dish soap and tube socks, or some such.

So, we have a good indicator to watch to see if the American economy is under-demanding good paying, middle class jobs.  At this point, almost every young middle class adult is attending some form of post-secondary education.  The community colleges and state universities provide broad, roughly interchangeable access to a wide range of career opportunities, and the cost of the education does not depend on the path of study.  An engineering undergraduate will typically pay the same as a sociology undergraduate.  So, once a student is enrolled in college, there are many paths of study that can be taken that all share a similar cost, but that have vastly different earning potential.

In an economy with a shortage of mid- and high- wage labor demand, I would expect to see an arms race within the student population to compete for the degrees that require more effort, but that will offer higher income.  Students seeing a bifurcated economy would be fighting to get into the better half.  This would lead to a surplus of graduates prepared for high wage work, and if the economy was dysfunctional, we might see a bunch of middle class graduates with STEM degrees driving taxis.

Instead, US universities have to fill their STEM programs up with immigrant students because there are few American students who consider them to be worth the effort.  I consider this evidence that there is, in fact, nothing in the middle class job market that is motivationally lacking for young workers.  And, it's not just schools.  If you have a sizeable engineering office in flyover country, it's likely populated with engineers from Vietnam and India.

I think we should look more closely at labor supply before we come to any conclusions on these matters.

Institutions, trust, and returns to capital

Washington, D.C.'s mayor has vetoed the big box minimum wage bill.  This is obviously good news.

It seems to me that, even with this veto, the clear first order market response will be for large retailers to think twice about opening new stores in DC.  Once they have completed the initial investment in new stores, they will always be one signature away from capricious, targeted hostile legislation from the city government.

So, there is now a new equilibrium within the DC city limits where large scale retail has an unusual amount of uncertainty that adds to long tail risk.  This equilibrium will demand a higher return on capital.

This is basically the problem with developing economies, where institutional improvements make capital investments safer, and foreign investment is lured into the growing economy.  But, since reversals are possible, and trust requires the passage of time, firms require a higher rate of return.  Nations that reverse to poorer institutions will lead to losses for those firms.  In nations that continue to improve, the realized returns of the investing firms will appear to be high.  Over time, as trust is gained, realized returns will settle to a long term reasonable equilibrium.

This is why it appears that production moves to places with low wages, when production really only moves to places with rising wages.  The necessary development of trust creates a lag effect where the higher required returns cause wages to rise more slowly than they would without this long tail risk.  So, there is a period of time where firms earn seemingly oversized profits at the expense of lower wages for the laborers in the developing economy.  Of course, the profits aren't oversized, they are just the payment received for taking on long tail risk with a binary and unpredictable payoff.  This generally calls for a high return, and also tends to produce survivorship bias in hindsight.

The Washington DC situation is the other side of this coin.  Novel new risks are being imposed on potential new investment in a city that is part of a nation with decent institutions, so investment into DC retail will slow down.  (Or, I should say, will continue to lag the surrounding areas, as poor governance is not new to DC or many other American cities.) The sad result will be that, predictably, in 5 years' time, large scale retailers will be making unusually high profit margins on their few DC properties, and DC wages will be below the surrounding areas.  And, just as predictably, there will be activists calling for this situation to be remedied with capricious, targeted hostile legislation.

In a way, the ability of US corporations to earn excess profits by moving production to developing economies is very similar to the well-documented momentum effect on individual US stocks.  Markets have a trust-but-verify mentality.  Efficiency means that prices fairly quickly react to new information, but not all the way, because the veracity of new information has its own risk distribution, with its own long tail of failure risk.

CEO's don't necessarily even need to model their investment decisions this way.  These factors will be built into their assumptions about wage growth and other costs, and their heuristics for how risky each location is.  So, they could account for all this and still misunderstand their investment decisions as being the result of moving to places with low wages.

But, it's not the low wages that attract capital.  Improving institutions lead to capital investment and increasing wages.  That's why most capital flows to high wage countries and why Korea and Taiwan are now among them.  That's why low wages aren't drawing capital to Congo, Zimbabwe, and Niger.  And, it's why American inner cities lack retail.

More interesting posts on 70's inflation

Ryan Avent at the Economist responds, and adds some interesting comments on how a sort of "rising tide" effect causes inflation in developing economies.

http://www.economist.com/blogs/freeexchange/2013/09/generations

And Karl Smith talks about the difficulty of objective analysis:

http://www.forbes.com/sites/modeledbehavior/2013/09/11/economic-history-a-benchmark-revision/

Minimum Wage & Job Growth

I still intend to follow up with some more minimum wage analysis, but in the meantime, this is a summary of a paper that has been getting some attention recently:

http://www.voxeu.org/article/minimum-wage-and-employment-dynamics

(HT: Patrick Sullivan)

Obamacare and Part Time Work

Menzie Chinn at Econbrowser and Spencer England at Angry Bear push back with some data.

I have been disappointed to see this idea of surging part time employment so readily accepted based on what looks like poor data.

I would have expected to see surging part time employment as much as the next person, and maybe it will if the law becomes fully implemented, but the data just doesn't support this yet.

JOLTS pickup

JOLTS data today did not confirm my concerns about early indicators.  This is good news.  12 month moving averages for Job Openings, Hires, and Quits are all at cyclical highs and Layoffs are at a cyclical low.  Most of the improvement was from positive revisions in the July data.

The data suggests that the decrease in the unemployment rate should be accelerating, which confirms the direction of the last couple of labor reports, even if the establishment data has been a smidgen disappointing.  An unemployment rate of 6.5% sometime next fall is looking reasonable.

Yields in Eurodollar markets look like they ticked down slightly on the JOLTS news today.  So, either the market disagrees with my assessment, or there is some expectation of a Fed overreaction.

I don't see any reason to question the current short term yield curve, and it looks like we are on track to leave the zero lower bound sometime in late 2014 - at least for a little while.

QE Expectations

This survey of economics bloggers, from Hudson.org has been making the rounds.  Survey results seemed generally reasonable.  But, I thought this one was kind of funny:

I like how they report that "a majority of the panel expects the yield to go up."  And, if there is one way to get a majority to vote a certain way in your survery, that would be to only give them one possible answer!  It doesn't look like the survey respondents minded, though, as they appear to be firmly in favor of rising rates.

Here is a graph of actual, observed 30 year treasury rates since 2008 (with QE episodes shaded):

How many QE's do we have to experience before the survey allows us to vote for the only outcome that we have actually observed?

Depending on where you set the start and end dates, 30 year treasuries have lost about 2 basis points a week when QE has been off and gained about 3 basis points a week when QE has been on.

Is this a case where the market gives an efficient price for something, in the face of a stated consensus opinion that is wrong?....so wrong that you aren't even allowed to give the right answer?

For the record, I expect long term rates to be fairly stable, with a slight upward bias.  But, it seems pretty clear to me that more QE would push that rate up.  I have argued that QE3 could have been reducing long term rates through a sort of uncertainty discount, so that its ability to increase rates has been muted until recently.  But, my impression of the consensus is that the survey expectations are simply coming from a liquidity effect.

Addendum:  It could be that an answer of falling rates was available, but was only left out of the report of results because nobody chose it, so my commentary should be drawn back slightly.

Quibbling about Labor Force Participation

Tyler Cowen links to this piece at the Washington Post.

It claims that there are 3 reasons for lower Labor Force Participation:

1) Demographics
2) The bad economy
3) Disability Insurance

On #3, I think it correlates highly with demographics, with some cyclical behavior, as can be seen in the chart from the article, so I think that this is really a secondary issue.  I'm not going to dig into the details here.

My quibble is on #2.  We have had a business cycle, and so, clearly, we should see some cyclical effects.  But, there is nothing unusual about this cycle, once we adjust for demographics.

The article makes two common errors:

1) Because the trend for LFP has been in secular decline since the late 1990's, the very strong labor market of the 2000's was obscured by the downward trend.  The article cites this calculatedrisk.com graph.

I haven't reviewed the referenced studies, but note that both of them make the LFP of 2006 appear to be below trend.  That is very unlikely.  So, both of these forecasts are starting out too high.  But, if we look at the slopes of these forecasts, they both predict LFP falling at .25% to .3% per year for the next 10 to 20 years.  That's basically what we are seeing.  At the bottom of the last recession, in 2004, LFP was at 66%.  Coming up on 2014, we are nearing 63%.  That's a 3% decline in 10 years, which is similar to the rate of change these forecasts predict.

2) Using LFP for 25-54 year olds does not account for all demographic issues.  The article uses this graph, and says, "obviously, retirement can't explain this":

First, I will just point out that it should be visually obvious, looking at LFP (the blue line) in this graph, that there are long term, non-cyclical factors pulling down the trend, and that we have just experienced a very typical cycle.  There is a little bump from 2004 to 2009, and, correcting for trend, it's basically the same bump you see in the late 90's, the late 80's, and the late 70's.

But, I'll take a moment to disaggregate this.  Here are men's LFP's by age:

There are several things to note here:
1) There is a significant fall-off in LFP as workers age to 45-54.  There are a large number of 45-54 year olds right now.  So, some of the demographic effect is still captured when using 25-54 year olds.

2) There might be increasing cyclicality among 25-34 year olds, which could be a long term trend or could be related to this specific cycle.  But, this age group's LFP has been recovering to trend strongly.

3) There is a very long term trend of LFP decline among all age groups.  Before 2000, this factor was obscured in the aggregated measures by the rising LFP of women.  But, even if there wasn't an issue with aging, we would still need to expect more than a 1% decadal decline in LFP.

4)  On the whole, the LFP's are not exceptionally low compared to trend.


Here are women's LFPs:

For each age group, behavior is similar, and, after a rise to the mid 70s, all age groups have appeared to take on the long term decadal decline rate of more than 1%.

Interestingly, there is no drop-off for women going into the 45-54 age group.  Here is a close-up of the past 14 years.  As with the men, there is a strong downward linear trend, within each age group.  There is a typical cyclical fluctuation of less than 1% above & below trend.  There is nothing especially unusual about the current cycle.

An unwillingness to internalize normal long term downward trends is causing undue hand wringing about cyclical LFP's.

1970s vs. 2000s: Gender Effect

Steve Waldman at www.interfluidity.com says that demographics caused inflation in the 1970's, not monetary policy.  Scott Sumner pushes back a little.

I think there are some semantics going on here, but if I understand Steve correctly, he is saying that the Fed was goosing the money supply in order to accommodate the quickly rising labor force brought on by the sheer number of baby boomers and the new tendency for young women to work.  I'm not sure I understand the mechanisms at work there, or whether it was a matter of the Fed meeting a true need or being fooled into over-inflating.

But, the discussion prodded me to think some more about the differences between these decades.  If the housing market and low real interest rates are the result of parallel demographics, why did the 70's see skyrocketing labor force participation while the 2000's saw plummeting LFP?

Jumping off from this post, I decided to make another adjustment to LFP.  Here is a graph comparing the actual LFP (and a forecast LFP that accounts for the aging labor force), to a modeled LFP that assumes the pre-baby boom LFP's had remained stable (in other words, no bump from working women):

The difference is working women!  Without them, the 1970's might just have looked like the 2000's, with declining LFP, and, if Steve Waldman is correct, low inflation.  But, now that female LFP has peaked, we don't have this factor to save us any more.  In fact, the problem is made worse.  My counterfactual LFP is based on stable age-group LFP's, but male LFP's across most age groups have been declining, slightly but persistently, for many decades.  Female LFP's peaked in the 90's and are now declining at a rate similar to the male rates.  So, not only are we lacking a fresh new female labor force, but women are actually leaving the labor force now.

This has tremendous implications for long term interest rate forecasts.  If there really is some reliable relationship between inflation and labor force growth (and Japan is another obvious anecdote in favor of this relationship), then we have several decades of low inflation ahead of us, and several business cycles where "zero lower bound" dynamics will be in play.

The odd thing is that the Fed should clearly be able to set long term inflation targets wherever they want, so if this is a factor, it would have to be playing out as some sort of institutional behavioral bias that is persistent through different eras of monetary thought and technique.

Addendum:  Steve Waldman responds, then Scott Sumner responds, with some very good comments by Mark Sadowski.  I think Waldman has some interesting points to consider, but Sadowski and Sumner have strong counter-evidence.

Notable Comments

A comment from "Gerald Quinn" in response to an essay by Kenneth Minogue (ht: Alberto Mingardi at econlog):

It surprises me that self-interest ever needs defending. It’s a bit like defending gravity. I’m also surprised that smart people like Professor Minogue who have taken the trouble to defend it seldom point out that self is flexible and conditional.

Self includes a series of interests that start with the contents of one’s skin, and proceed outward through family, home, friends, neighborhood, country, and beyond, to whatever cause, identity, or belief one chooses to own. It changes through experiences and external circumstances.

To me, the strangest thing about it is how self manages to enlist truth and justice as patrons. Anything that Self claims as its own almost always becomes true and just. And therein lies the challenge: a bigger self is often a better self, but when we reach to embrace more than what makes sense for us as in pathological empathy, the truth of a thing is lost and unthinking ideology is takes over.

A comment from "nobody.really" in response to another comment regarding a tribute to the recently deceased Nobel laureate Ronald Coase by Steven Landsburg:

"In the case of the rabbit/lettuce farmers, is the conflict really symmetrical though? After all the rabbit farmer damages the property of the lettuce farmer and not vice versa. Would you say that this is exactly counterweighted be the implicit damage dealt to the rabbit farmer for not being able to have rabbits run freely on his property? How do property rights figure into Coase’s argument?"

Excellent question!
The classic example in Law and Economics is the fence out/fence in controversy, illustrated in song and story: If your cow damages my crop, what remedy? Cue the song “The Farmer and the Cowman should be Friends.”
In the wide open spaces of the West, a farmer who failed to put up strong fences around his crops had no claim against the owner of the cow. But as more farmers arrived, gradually the laws would change to impose the liability on the owner of the cow to control his cattle – that is, a duty to fence the cattle in. Cue the song “Don’t Fence Me In.” I’m told you can trace the settlement of the American West by the dates that the laws change from Fence Out to Fence In.
But gosh, doesn’t it just seem intuitive that the farmer has the better property rights claim? Intuition is a funny thing. How long ago was it that my right to smoke was deemed intuitive, and your preference to breathe smoke-free air was deemed an unreasonable intrusion on my right?
The “Coase Theorem” states that where transaction costs are low, socially optimal results derive from having clear property rights, even if the rights are assigned arbitrarily. But in a world where transaction costs are high – especially a world when the number of parties to a potential transaction is almost infinite – the allocation of property rights influences the ability to achieve socially optimal outcomes. Consider fee simple ownership of land: If I value consent over use of force, how many parties would I need to contract with to secure “property rights” to a piece of land? Answer: All parties – both now and into an indefinite future. That’s a big transaction cost. Thus the philosophically arbitrary choice to recognize property rights in land – to privilege the claims of one person to exclude others – has huge social benefits. The alternative choice – to recognize everyone’s equal claim to use a piece of land – has the advantage of egalitarianism; it also leads to the Tragedy of the Commons.
The moral is 1) property rights are socially defined, not received from heaven, and 2) people who build their moral philosophies on the idea the property rights are sacrosanct are building on a foundation of sand. (Which is not to say that other moral philosophies have a firmer foundation….) 

The surprisingly low number of new homes

Modeled Behavior has added some analysis about the housing boom.  Here's their graph showing the number of new housing units per the number of additional population:


Considering the shrinking size of the average household, I'm surprised to see how low this ratio has been since 1990.  And, it's surprising to see how low it was, even at the peak in 2005.

So, even if my earlier analysis is correct, that prices in the 2000's boom were reasonable, why did the new demand for housing lead to higher prices instead of increased quantity?  Many areas of the depopulated inner parts of the country didn't see the price gains of the coasts and the growing metropolises, so maybe we have reached an era of development where location is important enough that we are willing to bid up the price of prime land.  Or, maybe strict zoning regulations are the issue, restricting the availability of new homes.

But, Las Vegas and Phoenix were epicenters of the housing boom, and these are both areas with relatively lax zoning restrictions, and significant growth potential, where much of the new building was suburban and exurban.  So, both of those explanations seem lacking.

At the height of the boom, demand for new tract homes in the Phoenix area was greater than the rate at which builders were able to permit new lots, so for a while there were weekly lotteries to determine which buyers could purchase homes in some developments.  I don't know if the bottleneck was regulatory or organizational, but there was a point when the demand for new homes was greater than the ability to supply them, even in the metro area that had managed decades of exponential growth.

This leaves the mystery of why this was the case when new housing units on a national scale were not at a particularly high point, compared to earlier periods.

There are a lot of seeming incongruities here.  I haven't found the narrative that ties them all up into a nice bow yet.