10/23/10 5:48 PMFederal Reserve Bank of Minneapolis Narayana Kocherlatkota Gets One Very Wrong - Grasping Reality with Both Hands

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Grasping Reality with Both HandsThe Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, Reality-Based, and Even-HandedDepartment of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 7080467; delong@econ.berkeley.edu.

Economics 210aWeblog ArchivesDeLong Hot on GoogleDeLong Hot on Google BlogsearchAugust 17, 2010

Federal Reserve Bank of Minneapolis Narayana Kocherlatkota

Gets One Very Wrong

There is no reason to think that the bulk of current unemployment is any sense"structural": if aggregate demand were higher it would melt away just asunemployment in 1982 melted away.

There is good reason to think that if we do nothing for the next two years and

unemployment remains elevated that a good deal of unemployment then will be"structural," not amenable to being cured by aggregate demand.

Fear of the transformation of current cyclical into future structural unemployment is areason for urgent action now to boost demand--not for passivity.

Ryan Avent reports:

Monetary policy: Why isn't the Fed acting?: [A]a speech today by Minneapolis FedPresident Narayana Kocherlakota suggests that some Federal Reserve voices aretaking the potential for structural unemployment very seriously....

What does this change in the relationship between job openings andunemployment connote? In a word, mismatch. Firms have jobs, but can’t findappropriate workers. The workers want to work, but can’t find appropriatejobs.... Whatever the source, though, it is hard to see how the Fed can domuch to cure this problem. Monetary stimulus has provided conditions sothat manufacturing plants want to hire new workers. But the Fed does nothave a means to transform construction workers into manufacturing workers.Of course, the key question is: How much of the current unemployment rateis really due to mismatch, as opposed to conditions that the Fed can readilyameliorate? The answer seems to be a lot.... Most of the existing

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unemployment represents mismatch that is not readily amenable to monetarypolicy.

And Ryan comments:

That's a huge statement: according to a Fed president, most of the currentunemployment cannot be eliminated by monetary policy. Does this make sense?Readers won't be surprised to hear me say that while structural factors are surelycausing some unemployment, it's a bit of a leap to argue that most of it can betraced to those barriers.... [I]f structural barriers were the main factor leading tohigh unemployment, one would expect to see an inflationary response—efforts toincrease hiring above levels the economy can sustain would lead to rising wagesand prices. Firms faced with too few qualified workers should be increasing salaryoffers. And obviously, we're not observing these trends. And listen to MrKocherlakota himself describe the scale of the output shortfall....

[T]his number actually understates the economic problem.... If the economyhad actually grown at that [normal] rate over the past two and a half years,we would have between 7 and 8.2 percent more output per person than we doright now. My forecast is such that we will not make up that 7-8.2 percentlost output anytime soon....

In short, this is a troubling revelation. It would be useful to know whether otherFed members are thinking along similar lines. Certainly Ben Bernanke's commentshave not reflected this view. But the lack of significant action from the Fed mayitself speak volumes.

Brad DeLong on August 17, 2010 at 11:25 AM in Economics, Economics: FederalReserve, Economics: Macro | Permalink

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Comments

Robert Waldmann said...Kocherlakota has to know that the way to detect missmatch is to compare hiring toexpected hiring given unemployment and vacancies -- that is look at the matchingfunction not the Beveridge curve. I have calculated the ratio of actual to predictedhiring as 1.00 something. Does he have a different calculation or has he decided not tobother with numbers ?

Even if one grants him the 60 year old approach to theory and econometrics and looks

10/23/10 5:48 PMFederal Reserve Bank of Minneapolis Narayana Kocherlatkota Gets One Very Wrong - Grasping Reality with Both Hands

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only at the Beveridge curve, he is basing his argument on one data point. I know hehas a very impressive CV. I don't want to check his academic work as I suspect I won'tbe surprised at all at the level of his analysis as a policymaker.

Reply August 17, 2010 at 12:06 PMSimon van Norden said...I've read over the text of his speech and his comments on the matching function. Theconclusion that "Most of the existing unemployment represents mismatch that is notreadily amenable to monetary policy" mystifies me; it seems to come out of thin air.Certainly, it is not a conclusion that the analysis he presents in the speech particularlysupports.

He builds a case that, because vacancies have increased while unemployment hasremained high, the historical relationship between these two has changed. I don't seeany discussion of how he then concludes (1) that aggregate unemployment is no longerresponsive to monetary policy, or (2) that in this new relationship, it is vacanciesrather than unemployment that matter most for future inflation.

What am I missing?

Reply August 17, 2010 at 01:12 PMNeal said......manufacturing plants want to hire new workers....

Is he nuts? Is this the outlook of most of the Fed--that hiring is slow because they can'tfind people to hire?

Just because there are anecdotes of some factories finding it difficult to hire people atpoverty level wages doesn't preclude the fact that there is excess capacity and greatlydiminished demand in most fields and most geographic areas.

The "mismatch" today that applies today is the gap between what people can spend andwhat they want to spend. That gap was previously bridged by more and more credit.

Find a way of filling that gap and, voila!, employment returns.

It doesn't help that corporations return to profitability has been fueled, in part, by off-shoring more blue and white collar jobs.

You also can't return to full employment on poverty-level wages either.

Reply August 17, 2010 at 01:35 PMOmega Centauri said in reply to Neal..."It doesn't help that corporations return to profitability has been fueled, in part, by off-shoring more blue and white collar jobs."To the extent that that statement is true, it would imply that we are in fact creatingstructural unemployment.

We also have much lower geographic flexibility than usual. People who are seriouslyunderwater in their mortages are pretty resistant to the idea of moving to a differentmetro area.

Reply August 17, 2010 at 03:38 PMsave_the_rustbelt said...For the youngsters in the crowd, 1982 was pretty brutal.

But 1982 was a church social compared to this mess.

Underemployment is structural and unemployment is headed that way.

Too many fantasies about service economies and a world dominated by finance.

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Reply August 17, 2010 at 09:02 PMChris of Stumptown said...I agree with Kocherlakota that the US situation is structural. If you read his speech itmay have seemed like it came out of thin air, but bear in mind that his address was tobusinesspeople about how the Fed functions. It was pretty clear to me that he wasreferring to the Beveridge problem.

What I thought was more interesting was his position that short term rates need to riseto avoid deflation. Bullard has been making this point along a somewhat different trainof thought. Check out his WSJ editorial that the next step is outright Treasurypurchases. So maybe there is a faction that wants more quantitative easing with higherFed Funds rate.

The question is where does Bernanke fit in. The common view is that the hawks are adistinct minority, but Bernanke is shrewd. Is this going to give him cover to adopt thisviewpoint? He is clearly an academic expert on deflation and the great depression. But,Bullard's 7 Perils paper lays out some powerful reasons why ZIRP may lead the US to aJapan style deflation trap.

In any event the Fed has enough on its plate staving off deflation. Let fiscal makers dotheir jobs and provide fiscal expansion and structural reform. That is better foremployment than bluntly managing rates.

Reply August 17, 2010 at 09:22 PManon said...I think they should have done the stimulus by sending checks to people who are not inthe higher income brackets. They'll start spending more money probably before theyeven get the checks. Government spending takes longer to increase the numbers. If thegoal is to make a recession end earlier rather than later, one should give priority to thepolicies that increase spending early, not later.

Reply August 18, 2010 at 12:47 AMMin said..."There is no reason to think that the bulk of current unemployment is any sense"structural": if aggregate demand were higher it would melt away just asunemployment in 1982 melted away.

"There is good reason to think that if we do nothing for the next two years andunemployment remains elevated that a good deal of unemployment then will be"structural," not amenable to being cured by aggregate demand.

"Fear of the transformation of current cyclical into future structural unemployment is areason for urgent action now to boost demand--not for passivity."

Hear, hear! Jobs now!

Reply August 18, 2010 at 10:50 AMAndy Harless said in reply to Robert Waldmann...Actually, I think the problem is not that he's using an old model but that he's using onethat's inappropriate for the question he wants to answer. He refers in a footnote to theShimer model, which I found here:

http://home.uchicago.edu/~shimer/wp/mismatch-print.pdf

As far as I can tell, this model assumes that all shocks are productivity shocks, sothere's not really any place for cyclical unemployment in the Keynesian sense. Soessentially Kocherlakota is using a model that assumes all unemployment is structural

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and using that to draw a conclusion about a change in the amount of structuralunemployment. At least, this is my interpretation without having read the paperclosely: I don't think the model allows you to interpret movements along the Beveridgecurve as a Keynesian business cycle phenomenon, but Kocherlakota is implicitly doingso when he implies that monetary policy would be effective in dealing with cyclicalunemployment.

Reply August 18, 2010 at 01:46 PMjh said in reply to Andy Harless...That's not quite right. He's using that paper as a baseline. The model hasunemployment, but doesn't attempt to model structural unemployment at all. (That is,it's not true that Shimer's model "assumes all unemployment is structural." It's allfrictional and cyclical.) So Kocherlakota compares the unemployment rate predicted bythe model to the actual unemployment rate, and argues that the difference is largelystructural.

Reply August 18, 2010 at 04:07 PMJim Lund said...Structural unemployment isn't a great factor today, but... the most likely case is thatthe unemployment rate stays above 7% for the next two years, likely even longer (4years?). Most likely, the US leaves this recession with a great deal of structuralunemployment. Two years from now you'll be tracking the rise in early retirementsamong the 62-67 yo segment as the factor bringing down structural unemployment.

Reply August 18, 2010 at 08:57 PMAndy Harless said in reply to jh...As far as I can tell, Shimer models all unemployment as the result of mismatch, hencethe title of the paper. (Whether you want to call that "structural" is a semanticquestion, but Kocherlakota seems to equate "mismatch" with "structural"unemployment.) It seems contradictory to attribute specifically to mismatch theunemployment that cannot be explained by the model in the paper. I would think itshould be exactly the opposite: unemployment that cannot be explained by a mismatchmodel is due to something other than mismatch, such as deficient aggregate demand.

Reply August 20, 2010 at 12:58 AMjh said in reply to Andy Harless...When Kocherlakota writes about the "stable" relationship between 2000-2008, he'sthinking about Shimer's model, as he makes clear in the note and the comparison hemakes. Shimer's model allows for "productivity" shocks to expand the number ofavailable jobs (which I think of as a cyclical effect), but even without any shocks toproductivity, there will be some level of unemployment from mismatch (which I thinkof as frictional). (As an aside, "productivity" means something different here than in,say, RBC models.) Kocherlakota is clearly comparing the current unemployment rate tothat "stable" relationship ("Were that stable relationship still in place today...we wouldhave an unemployment rate of closer to 6.5 percent, not 9.5 percent"). After makingthat comparison, he immediately follows with, "Given the structural problems in thelabor market..." So I take those "structural problems" to correspond mostly to thatdiscrepancy.

If he really meant to equate "mismatch" to "structural" unemployment, he would haveto argue that unemployment from 2000-2008 (the "stable relationship") was entirely"structural". (Since, as you say, all unemployment in Shimer's model is due tomismatch.) I very much doubt that he meant anything like that. Although I do think

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Me: Economists:

PaulKrugmanMark ThomaCowen andTabarrokChinn andHamiltonBrad Setser

Juicebox

Mafia:

Ezra KleinMatthewYglesiasSpencerAckermanDanaGoldsteinDanFroomkin

Moral

Philosophers:

Hilzoy andFriendsCrookedTimber ofHumanityMarkKleiman andFriendsEricRauchwayand FriendsJohn Holboand Friends

the terminology could have been more clear, I take his "In a word, mismatch" to meansomething like, "worse mismatch than usual" -- that "structural problems" have causedthe matching process to work much more slowly than in the recent past. He's arguingthat Fed policy may affect labor demand (as a productivity shock, in terms of themodel), but probably has no effect on parameters that affect time-to-match.

Reply August 20, 2010 at 06:23 AMComments on this post are closed.

Economics Is not a Morality PlayNew York Times (blog) - Sep 28, 2010Brad DeLong catches someone wondering if I am actually advocating war as asolution to our problems. Against stupidity, the gods themselves … ...Related Articles » « Previous Next »

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