Tuesday, December 9, 2014

October JOLTS and a Rant about Risk & Recovery

JOLTS data continues to signal strength in the labor market.  As with the regular employment data, this probably will be less important in the near term.  Strength in the labor market seems persistent, and at the top of the cyclical range.  Now it is just a matter of remaining in this range.  Eventually, JOLTS might be an early signal of a cyclical downturn, but that seems to be a distant issue for the time being.

Hires, openings, and quits continue to accelerate.  Not only the levels, but the trend growth rates are as strong as they have been in this recovery.  We should be very optimistic about near term real economic growth.

Openings per unemployed worker continues to recover.  I think the Beveridge Curve will continue to persist with this rightward shift, partly as a result of persistence in the inflated unemployment rate, and partly because of a higher openings rate, related to the aging labor force.  An older labor force should also tend toward a lower unemployment rate, so if we can manage to extend this recovery for another five years and work off the persistent cyclical unemployment, this relationship might move back to the previous trend.

The next graph demonstrates some of these labor force changes (some of which are simply demographic).  We can see that, compared to the early 2000's, the Quits Rate has declined relative to the Job Openings Rate.  Older workers tend to have a lower Quits Rate, so this shift will probably remain in place for some time, and then begin to shift back as baby boomers retire.

In general, these shifts appear to be relatively mild in the historical context.  Here is a long term graph of the Beveridge Curve from the San Francisco Federal Reserve Bank.  We are still in the general range of the 60s, 90s and 2000s, well left of the 70s and 80s.  (Openings are currently at 3.3%, unemployment at 5.8%.)

Generally, I think we tend to think of this relationship as shifting from left to right, so we think of rightward shifts as bad, since they are related to higher unemployment.  But, I think the relationship may be more subtle than that.  A higher Openings Rate should lead to a faster employment recovery rate.

So, we see the shift right in the 1970s and 1980s, and we might relate this to employment frictions.  And there may be some truth to this.  But, we could also view that period as having shifted upward.  The higher relative Openings Rate may have helped to bring faster recoveries.  That suggests fewer cyclical frictions.  Possibly this is related to the slower rates of recovery in the past three cycles.  On the other hand, openings were relatively low in the 1950's, and cyclical recoveries were very fast in that decade.

Risk Premiums, Real Growth, and Inflation

I wish there wasn't such a perception about strong labor markets leading to inflationary pressures.  This seems to be a false notion, coming out of a narrative-based interpretation of labor markets.  Strong quits and openings suggest a safe context for job searching among the labor force.  In effect, this is the sign of a low risk premium for labor, which I would expect to run parallel with the risk premium for equity.  This should lead to greater risk-taking - both through more innovative investments and through more churn in labor markets.  The strongest effect of this risk taking should be higher real economic growth.

Some of the inflation narrative may come from a misinterpretation of the relative level of wages and profits.  In a low risk context, risk premiums will decline and interest rates will rise.  This will be related to higher leverage.  Even if returns to capital remain level, the higher leverage will cause more of the capital returns to be allocated to debt (interest).  Profit margins will decline as a result of this leverage, but this is an arbitrary distinction with regard to income shares.

Lower risk premiums also mean that compensation will rise.

We tend to talk about debt as the result of careless or greedy consumers and speculators.  But, the movement in equilibrium debt levels is the product of much more subtle effects from these changing risk premiums.

We need to rid ourselves of this notion that investors and corporations are a teeming throng of capital-bearing zombies, mindlessly bidding up assets with an insatiable and unsustainable lust for profit.  And, we need to rid ourselves of this notion that labor and capital are defined by a bidding war for a fixed pie of production.

In the three modern examples of extended, decade long recoveries, the mature portion of those recoveries (the late 60s, late 80s and late 90s) are associated with rising compensation, rising interest income, and declining profit shares.  These are the signs of an economy with low risk aversion and lower frictions to real growth.  Those who push for a manipulated end to the recovery because of financial stability concerns or because of concerns about wage inflation are needlessly hampering our shared abundance.

Commenter TravisV might want us to look at the late 1960s (see graph below).  This is the period where the Fed began to err on the side of higher inflation.  Look at compensation during that period.  If the Fed doesn't decide it has to kneecap the recovery, this is what we could have.  Surely we can manage this without going all the way to 10% inflation.  But, if the Fed prefers another demand shock to even 4% inflation, which appears to be the case, then this positive outcome seems unlikely.

Misplaced emphasis on interest rates and inflation creates confusion here.  It isn't so much the inflation itself that would lead to this sort of recovery.  It's the lowered risk of an NGDP shock, which then lowers risk premiums.  Persistently accommodative Fed policy will lower profit shares, and we will all be fat and happy.  There is no reason for divisiveness on this matter.  Political factions are unified in accepting false premises over which to argue, when no argument is necessary at all.

There doesn't even need to be a supply side vs. demand side argument.  Long economic expansions clearly lead to falling profit shares.  Call it "trickle down" if you like, but labor clearly benefits over time from a healthy corporate sector.  And, how do we get there?  Demand side stability.  I'm ok, you're ok.  Can we stop fighting over false premises?  (Here's a follow up.)

Be careful.  The two vertical axes are not scaled the same.


  1. TravisV here.

    Fantastic stuff! I also read these two posts today and was a huge fan: