How would the Fed respond to the elimination of extended UI?

This is from a recent editorial by Amanda Alix:

A body blow to a recovering economy
The personal suffering will be terrible enough, but the damage to the fragile economy is sure to cause further disruption. Monthly stipends are recycled back into the economy as recipients buy the necessities of everyday life. Preserving that cash infusion, despite the cost of the program, could increase the country’s gross domestic product by 0.2% this year, while adding another 200,000 jobs.

Another problem involves the unemployment rate, which could drop by 0.5% as the long-term jobless are no longer counted as “looking for work.” A similar scenario occurred last year in North Carolina, when 170,000 people lost jobless benefits in a bid to cut state costs. The state’s unemployment rate dropped quickly to 7.4% from 8.8% as those people were no longer considered unemployed.

A drop in the national unemployment rate could have more serious consequences. The Federal Reserve has specified a jobless rate of 6.5% as one economic indicator that would prompt the Fed to cut back on its accommodative monetary policy and consider raising short-term interest rates.

While the Fed stresses that interest rates will very likely stay low well beyond the time the jobless rate hits the 6.5% mark, a falling unemployment rate will likely spur the speed-up of the so-called taper. It’s very possible the announced reduction of $10 billion in the Fed’s monthly $85 billion bond and mortgage security buying plan could be accelerated if the jobless rate hits 6.5%, particularly if the rate continues to drop.

This could send long-term interest rates surging, hurting housing and the greater economy. Clearly, there are other factors, such as inflation, that the Fed will consider as it moves to wean the economy from its quantitative easing policy. It is notable, however, that the Federal Open Market Committee clearly regards a national unemployment rate of 6.5% as a sign of an improving economic climate — not the byproduct of shutting off the benefit supply to those who have been unable to secure viable employment.

If we learned anything in 2013, it is that the first paragraph is probably wrong, due to monetary offset.  But it’s the final paragraph that perked my interest.  A few comments:

1.  This is a good example of why the Fed should not target the unemployment rate.

2.  The final sentence of the quotation seems wrong.  Not only does the Fed not regard 6.5% as “clearly” the key threshold, a few weeks ago the Fed even went out of their way to state exactly the opposite, that rates would probably stay low well beyond the 6.5% threshold.  Thus the Fed behaved exactly as one would expect if they accepted Amanda Alix’s view that the repeal of extended UI program would quickly reduce the measured unemployment rate without boosting AD and jobs.

I’ve often been critical of the Fed’s willingness to allow NGDP growth to drop sharply over the past 6 years, which boosted joblessness and worsened the financial crisis.  But in fairness the Fed does seem to be pretty good at offsetting the impact of fiscal policy.  There are lots of good (humanitarian) arguments for reducing UI insurance more gradually, but the impact on AD is not one of them.

PS.  For what it’s worth my prediction is that the measured unemployment rate will fall by about 0.7% in 2014, or by 1.2% if extended UI is not re-instated.  This is a very rough guesstimate, as it’s difficult to know how many discouraged workers would come back if the economy improves.

Regardless of what you think about extended UI, everyone should agree on the following:  If we really do need 73 week extended UI 5 years after Obama took office, then the 2009 stimulus bill failed. Perhaps it failed because it was too small, or because the GOP blocked further stimulus, but it clearly failed.

PPS.  The entire unemployment system should be gradually replaced with personal UI accounts, grandfathering in those in the old system.  When people retire any unused funds in their UI accounts could be used for retirement, or for bequests.

PPPS.  I just noticed another article:

“That would mean there is almost a billion dollars we are losing from the economy because of not extending unemployment insurance benefits,” Katz said in a conference call organised by House Democrats.

He later told the Guardian that the calculation was based on the “multiplier effect” of cancelling the benefits program, which had been forecast by the Congressional Budget Office (CBO). Applying the CBO’s estimated multiplier effect to the $400m per week being lost in benefits, Katz said, translated into a cost to the economy of between $600m and $1bn.

“It is actually fiscally irresponsible not to extend unemployment benefits,” he said. “The long-run cost to the taxpayers will be much higher from disconnecting people from the labour market.”

After 2013, it’s hard to believe there are still people who believe in “multipliers.”  Here’s a better argument for extended UI:

“When Congress first past this version of emergency unemployment compensation in 2008, and the president [George W Bush] signed the law, the unemployment rate was 5.6%, and the average duration of unemployment was 17.1 weeks. Today, the unemployment rate is 7%,” Perez said. “The average duration of unemployment is now 36 weeks.”

Interestingly, Brad DeLong predicted that Bush’s decision would boost the unemployment rate by 0.6% points within 4 months, and was exactly right.  Even liberals believe extended UI boosts the unemployment rate when the level of unemployment is close to the natural rate.  Not sure what Bush was thinking . . . 


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28 Responses to “How would the Fed respond to the elimination of extended UI?”

  1. Gravatar of Brian Donohue Brian Donohue
    13. January 2014 at 07:25

    Nobody serious regards 6.5% as a magic number for the Fed. In the latest jobs report the rate dropped to 6.7%, cuz denominator, and nobody interprets this as accelerating the taper- quite the opposite, cuz numerator.

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. January 2014 at 08:10

    Of course Bush, in 2008, had Keynesian theory on his side; to alleviate the downward spiral (as everyone cut back on their spending) government spending could theoretically substitute for the now vanished private spending. That’s logically definsible.

    But it’s five years later, there is no downward spiral, only an anemic upward movement that increased government spending is probably retarding.

  3. Gravatar of Doug M Doug M
    13. January 2014 at 09:39

    If we saw unemployment fall without seeing employment rise, I highly doubt that the Fed would pull back on QE, regardless of the level of the unemployment rate.

  4. Gravatar of SG SG
    13. January 2014 at 13:13

    This is off-topic, but I was reading a really good piece in the WaPo on Stanley Fischer and this sentance jumped out at me:

    “Central banks generally have a lot of control over how much their countries’ currencies are worth relative to others.”

    Those are the author’s words, and the excessive hedging is sympotmatic of the public’s inability to understand the role of the Fed and monetary policy generally. It should read:

    “Central banks (absent total political disaster like civil war) ALWAYS have TOTAL control over how much their countries’ currencies are worth relative to others, regardless of interest rates.”

    That’s the lesson of the Swiss devaluation, and if people understood that point better, they would understand market monetarism much better.

  5. Gravatar of SG SG
    13. January 2014 at 13:21

    Another great mistake (I hope this is the author talking again, and not a paraphrase of Stanley Fischer):

    “What if, next month, we discover there’s much less oil in North Dakota than we all thought, the price of crude goes through the roof, and suddenly inflationary pressures emerge? The Fed can’t credibly promise to keep rates low in that scenario, however unlikely it is.”

    http://www.washingtonpost.com/blogs/wonkblog/wp/2014/01/13/stanley-fischer-saved-israel-from-the-great-recession-now-janet-yellen-wants-him-to-help-save-the-u-s/

    It’s a great mistake because it’s the same mistake that the Fed made in 2008. I love how 18-year-old amateur economics bloggers know the difference between supply-side and demand-side inflation, but our central bank and the press that covers it do not.

  6. Gravatar of Benny Lava Benny Lava
    13. January 2014 at 13:36

    Since we are on the subject, do you think that there is a natural rate of unemployment and that it has changed a lot over the last decade? I am skeptical of the concept but it keeps coming back.

  7. Gravatar of Doug M Doug M
    13. January 2014 at 13:37

    “Central banks (absent total political disaster like civil war) ALWAYS have TOTAL control over how much their countries’ currencies are worth relative to others, regardless of interest rates.”

    That isn’t true. There are plenty of cases of a central bank attempting to maintain a peg that eventually prove to be impossible to maintain.

  8. Gravatar of SG SG
    13. January 2014 at 13:38

    @ Doug M

    Examples?

  9. Gravatar of Doug M Doug M
    13. January 2014 at 14:02

    Argentina 2001.

  10. Gravatar of Morgan Warstler Morgan Warstler
    13. January 2014 at 14:02

    Benny,

    I think you should read the best Keynesian alive, Roger Farmer:

    http://rogerfarmerblog.blogspot.com/

    There are many equilibriums / natural rates for unemployment based on the government’s stance of regulations, labors laws, taxes etc.

    Farmer says the key to getting a new lower natural rate of unemployment, according to KEYNES is to awaken the animal spirits of the private sector.

  11. Gravatar of TravisV TravisV
    13. January 2014 at 14:30

    Glad to see Ponnuru and Pethokoukis say this:

    “Tight money and anti-poverty policies are a bad combo for GOP”

    http://www.aei-ideas.org/2014/01/tight-money-and-anti-poverty-policies-are-a-bad-combo

  12. Gravatar of Benny Lava Benny Lava
    13. January 2014 at 15:09

    Honestly, from a philosophical point of view the idea of a “natural” unemployment rate seems silly. Is there an artificial unemployment rate? How do you distinguish one from the other? More baggage economists carry around from a more superstitious age.

  13. Gravatar of TravisV TravisV
    13. January 2014 at 15:59

    Prof. Sumner,

    Brad DeLong just wrote a huge post exploring Ryan Avent vs. Larry Summers:

    http://bit.ly/1dqZZOy

    Here’s one of his comments:

    “A 5% per year inflation target, this argument I will call Greenspanite goes, demonstrates to investors everywhere that effective price stability is really not high on the central bank’s list of priorities. Emergencies and politics will pressure the central bank, and if effective price stability is not the highest priority it will succumb to the temptation to relax its inflation target. Thus a central bank that has been happy with a 5% per year rate of inflation last year will be willing to tolerate a 7% per year rate of inflation next year. Thus if past inflation has been 5% per year, expected inflation will be 7% per year–and the central bank will either watch inflation creep up until it escapes from all control and 1982 is required again to re-anchor expectations again, or the central bank will have to perennially target an unemployment rate higher than the natural rate in order to keep actual inflation at 5% per year below expected inflation at 7% per year, with enormous resulting economic losses.

    This Greenspanite argument is, I think, relatively strong within central banks. I recall one very, very senior monetary policymaker telling me in the late 1990s that Greenspan had in fact pushed the envelope hard in defining a 2% per year inflation target as “effective price stability”, and that had been a gutsy loose-money move for someone in his position.”

  14. Gravatar of benjamin cole benjamin cole
    13. January 2014 at 16:56

    Having the Fed create money and buy bonds while unemployment benefits are extended is an interesting idea. In a sense we are putting new money into the hands of the unemployed and not increasing the national debt.
    I like the idea but only in the short run and it is a work disincentive…as are SSDI and VA disability benefits…

  15. Gravatar of Andy Harless Andy Harless
    13. January 2014 at 17:47

    If we really do need 73 week extended UI 5 years after Obama took office, then the 2009 stimulus bill failed.

    I don’t see how this follows, unless you assume that the stimulus bill was predicated on a “pump-priming” theory (which is not standard NK theory), and even then we really don’t know how the counterfactual case would have turned out: one plausible version of the pump-priming theory would say that the stimulus avoided a total collapse, which, if it had happened, might have left things today much worse than they are. Without pump-priming, a fiscal stimulus that happened in 2009 and 2010 should be largely irrelevant to conditions in 2013. The mainstream interpretation of the stimulus would be that it just took the edge off the worst of Great Recession (and wasn’t necessarily intended to do more), which in no way contradicts the observation that the economy is still much too weak.

  16. Gravatar of Andy Harless Andy Harless
    13. January 2014 at 17:51

    (You can certainly make a case that things would be better now without the stimulus, because the Fed would have been forced to change its approach in a more dramatic and lasting way, so the stimulus might have failed, and today’s weakness might be evidence of that, but it doesn’t seem like something to which “everyone should agree”)

  17. Gravatar of ssumner ssumner
    13. January 2014 at 19:35

    Brian and Doug, I agree.

    SG, Yes, that inflation comment is pretty bad.

    Benny, Yes, I think the natural rate is around 5% to 6%, probably closer to 5%.

    Doug, Yes, some pegs are politically impossible, but that’s different from technically impossible.

    Andy, I should have made myself clearer. By “fail” I did not mean had no effect, I meant it did not get the economy back to the natural rate. Any sensible stabilization policy should get you back to the natural rate in 2 or 3 years at most. If you don’t do that then the stimulus was too small. We still have “emergency” unemployment comp after 5 years, which means the stimulus was far too small (of course I would have preferred monetary stimulus, but that’s a separate issue.)

    Suppose people are living in emergency tents 5 years after Hurricane Sandy. Then I’d say the disaster relief failed, which doesn’t mean the tents are worse than no tents.

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. January 2014 at 19:50

    One of the Hartz reforms in Germany in the early 2000 was to cut the length of unemployment benefits. The 11% rate steadily declined to about 5.5% by 2008.

  19. Gravatar of Kevin Erdmann (aka kebko) Kevin Erdmann (aka kebko)
    13. January 2014 at 20:08

    I am very suspect of the idea that EUI is stimulative at all.

    1) Even if one accepts the idea that economic redistributions stimulate through consumption, EUI is not a very effective means for it. The average working income of low-duration unemployed is fairly low. But, low income workers tend to re-employ more quickly, and most are reemployed by the end of regular UI. I estimate that the average worker who’s been unemployed for 50 weeks is 39 years old and had income within 15% of the population average. So, as EUI is extended, the redistribution is going to people with more of a personal safety net of savings and expected income.

    And, in any case, I would like to see numbers on how much EUI affects the spending behavior of the recipients. I would expect a temporary lack of income to lead to dissaving. So, I am not sure EUI benefits change spending that much. I would expect beneficiaries to be living on a temporary, minimal budget, and EUI would substitute for dissaving.

    2) There is an obvious disincentive for working. Many recessionary policies are aimed at boosting economic activity in the short term, with costs shifted to the future. But, with EUI, we are disincentivizing current production with the justification that it will help create better job matching in the long run.

    So, I would argue that, even without monetary offset, EUI reduces economic production during the downturn, creates all the standard distortions of public taxing and spending decisions, and even reduces future production through an income effect because it reduces the cost of dissaving among workers who prolong their unemployment duration. All of this is done in order to redistribute to people with nearly average income. (It’s important to keep in mind, I’m talking about EUI, not about standard 26 week UI.)

    So, I think if Congress allows EUI to stop, it will be very stimulative for 2014. The end of the policy will be stimulative itself. And, if the Fed thinks that (1) the policy was stimulative and (2) the new post-EUI unemployment rate is biased to the low side, then they will provide more monetary stimulus than they would have otherwise. We might finally get monetary policy that is stimulative enough.

    The return of long duration workers to work will increase real GDP and the newly-stimulative Fed will increase inflationary pressures. NGDP will soar.

  20. Gravatar of Kevin Erdmann Kevin Erdmann
    13. January 2014 at 20:27

    The quote from Amanda Alix reflects what I call the Wizard of Oz theory of the Fed. Why do so many people act like the Fed sets interest rates like I set the thermostat in my house?

    Interest rates will go up because the economy will be improving, the banks will be continuing to improve their capital positions, investment will increase, expectations will improve, risk premiums will fall, etc.

  21. Gravatar of Brian Donohue Brian Donohue
    13. January 2014 at 21:23

    kebko,

    Very interesting comment.

  22. Gravatar of Saturos Saturos
    14. January 2014 at 00:21

    Off topic: what do you think of this economic analysis?
    http://www.theguardian.com/commentisfree/2014/jan/13/north-sea-oil-money-uk-norwegians-fund

  23. Gravatar of Dan W. Dan W.
    14. January 2014 at 05:38

    Twenty-five years ago, I was on a construction job and a worker declared, “I only need to work 6 weeks and then I can begin collecting UI again”. Sure enough, 6 weeks later he was “fired”. I witnessed this yet according to Paul Krugman it never happened.

    The UI debate reveals the chasm that exists between micro and macro economic theory. Micro theory states that subsidizing people for not working will lead to less work. Macro theory asserts that people want to work but cannot because jobs simply do not exist. Thus the subsidy is both compassionate and a means of increasing AD.

    When pushed the macros admit that the micro theory is valid but they still wave their hands saying that the disincentive is not as great as they think. At this point we end up with a shouting match because economic arguments that intersect with social policy always end up in shouting matches.

    But the UI program can be improved to make it more beneficial to society and the person. For example, let’s make the reception of UI benefits contingent on the person performing 20 hours a week of community service. This raises the personal cost of receiving UI, increasing the incentive of the person to accept a real job. At the same time it gives the person a way to contribute to society while still allowing time to continue a job search.

    But paying people not to work? That is about the most economic destructive thing a society can ever do.

  24. Gravatar of Morgan Warstler Morgan Warstler
    14. January 2014 at 07:05

    Dan, Get behind GI / CYB!

    http://www.morganwarstler.com/post/44789487956/guaranteed-income-choose-your-boss-the-market-based

  25. Gravatar of Dan W. Dan W.
    14. January 2014 at 18:31

    Morgan,

    I like the concept and would love to see it tested. I have concerns about the system being gamed but I don’t suppose the corruption could be any worse than what it already is.

  26. Gravatar of ssumner ssumner
    16. January 2014 at 06:30

    Saturos, Funny that he doesn’t mention the role of Labour.

    Dan, I’ve heard many such stories, some from people I know personally. Too many for them all to be apocryphal. And of course studies back up your claim.

  27. Gravatar of Britmouse Britmouse
    16. January 2014 at 07:54

    Thank goodness the UK had a massive productivity boom thanks to record levels of public sector investment funded by all those City bonuses in the 2000s… otherwise left-wing arguments about North Sea oil and the 1980s would look totally daft.

    Oh, wait.

  28. Gravatar of As Senate Fails to Pass UI Extension, Somewhere Scott Sumner is Smiling | Last Men and OverMen As Senate Fails to Pass UI Extension, Somewhere Scott Sumner is Smiling | Last Men and OverMen
    16. February 2017 at 20:25

    […] in their UI accounts could be used for retirement, or for bequests.”      https://www.themoneyillusion.com/?p=25754      I mean if you agree with this policy which party would make it law tomorrow […]

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