Part 7: Policy Responses and Effects and the Rigid European Labor Market

November 21, 2011

Waller explores how well employment is responding to monetary and fiscal policies, including zero interest rates, low tax rates and close to $1 trillion in stimulus spending. He also draws a cautionary lesson from Europe's high unemployment during the 1980s and 1990s.


Christopher Waller: All right, here's another pre-event poll. So now I'm going to move into—I've told you what it is. Here are some of the issues. Everybody says, "Okay, dude, what are you going to do about it?" And I say, "I give it to my boss. He takes care of it." So how much do you think the Federal Reserve can do to affect the unemployment rate situation in the U.S.? About a fourth said "some." 37 percent said "a little." 25 percent said "it's pretty much beyond the Fed's control." So not many of you have a great amount of faith in us being able to really get that unemployment rate down.

Now what has actually happened during this recession? Well, let me tell you, it isn't from a lack of trying to try to help get the economy on its feet. We've lowered interest rates to zero to try to stimulate spending. And the standard mechanism is the following. If you drive down interest rates, it's cheaper to borrow. It's cheaper to finance investment. It's cheaper to finance consumer durables. It's cheaper to finance housing. Normally, all of those things would start kicking off when we did this. All right? That's the typical way we think about policy working.

But we haven't seen any kind of rebound in investment or in consumption of consumer durables. There is a kind of a drop-off. They're growing again, but it's like a permanent drop in the level of consumption that's happened. As a result, we haven't seen a lot of businesses hiring a lot, and we haven't seen a lot of spending on housing and durables. Now we know that a lot of the credit market stuff, people under water, this is killing the housing market. And after a few years of really low interest rates on houses, if you were eligible to buy one, you've probably bought one. So you've pretty much captured everybody who's on the sidelines looking for a house.

One of the things that also happens when we drive down interest rates, we make it cheaper, and people go refinance. And then they get a lower mortgage payment and they have some extra monthly income, and often some of that gets translated into consumer spending. We've pretty much done that for the bulk of the people. A lot of people are in this situation. They don't have 20 percent down anymore, because of the drop in housing prices. They don't meet the credit standards of the equity amounts. They can't come up with the extra cash. They can't refinance.

And it also doesn't affect jumbos. Okay? So it's very hard to get a lot of new action out of the refinancing margin. So we're somewhat constrained by all these forces. Fiscal policy has tried to do a tremendous amount. We had a huge stimulus plan, nearly $1 trillion in government spending. Tax cuts. We've all got a payroll tax cut this year of 2 percent—2 percentage points. And there's been a lot of action to try to do something. And, again, it doesn't seem to have had that much impact.

Now you can argue that it would have been a lot worse without these things, and instead of 10 percent unemployment, we might have had 15 percent. But we'll never know that. Okay? That's an experiment we'll never get to see what would have happened if we had not done this. All right? So all we can do as economists is then try to back out from the observable data what we think actually was the result of this. And, not surprisingly, there's enormous amounts of debate right now on that issue. But most of it seems to be, if it saved—if it did anything, it just kept it from falling much. It wasn't like it caused a big rebound in spending—or employment.

Now when we go around and talk to firms—part of President Bullard's job is to talk to a lot of business contacts in the St. Louis District. All the Federal Reserve presidents of the regional Feds do this. Then they bring that anecdotal evidence that's not in the big aggregate data. They bring that to the table and talk about it. And, overwhelmingly, you hear these kind of two explanations. Firms say, "I don't have any customers coming in the front door. And unless the customers show back up, I can't go hire." It's just low demand. This is just kind of demand is weak. People are not coming in.

And there's also very serious concerns about policy uncertainty. We just saw some of that today with the failure of the Super Committee. This is just going to generate more uncertainty potentially about what's going to happen with long-run U.S. fiscal situation. We can maybe say, "Ah, so what?" But look what's happened to Europe over the last two years. It's not a, "Ah, so what?" kind of moment. These are serious things and can cause great problems in financial markets in your economies.

Lots of new regulations come in—financial market regulation, new healthcare. We're still trying to sort out what the healthcare plan is going to do. Firms are still not sure. And then we're just not sure what the political situation is going to be. All of these things, firms are all like, "You know what? I'm going to just take a pass. I'm just going to sit on the side..." And now you throw in the whole Europe thing. They're like, "I'm going to just take a pass. I'm going to sit here and wait it out and just see what happens."

And then on the household side, the thing we're really running into, which is I told you that, you know, we tried to drive interest rates down to stimulate demand for consumer durables and all this. Well, by construction you were trying to get households to borrow, go into debt, which means leverage up. Well, what households have been doing for the last four years is going the other direction. They're trying to deleverage. They're trying to reduce their debt. They're trying to repair their balance sheets. So we're kind of fighting the tide of people are trying to get their debt down. And we're saying, "No, push it up." Okay? It's not working like we would have had it happen in the past.

And then the key thing that people point out is, housing was so overbuilt. It was such an important factor in this economic decline that we're not getting the rebound that we would typically see in housing. You have a recession and housing is one of the things that always gets hit. Oftentimes the Fed comes in. We drive down interest rates. Mortgage rates fall. People then say, "Okay, now I'm going to go buy a house and build a new house." And housing kind of picks up and takes you up out of the recession. It's done this. It went up, down, and like that. It's flatlined. And to just put the thing on its chest, it's not coming back for a while.

Now one of the things that President Bullard here has been arguing in speeches is that we want to be very careful of saying we're going to do certain policies until unemployment gets to a certain level. So there's some proposals out there that the Fed just do enormous amounts of policy easing in a number of different ways until unemployment gets down to, say, 7 1/2 percent. One of the problems is, we don't have that great of control over unemployment. Firms do. Okay?

We can tease people with interest rates to try to help the firms and stimulate demand, but at the end of the day, we don't create any jobs. The private sector does. And if they say no, there's not much we can do about it. Now one of the things that—we're trying to point out that you can get in a situation where unemployment is high and it just potentially stays there.

So I'm going to talk about what is a cautionary tale about European labor markets. Unemployment rates in the U.S. were much higher than kind of the key countries in Europe in the 1960s and '70s. Then that series of oil shocks in the 1970s drove these economies into recession, and unemployment rates shot up. And like I said, in '81, '82, it was 10 1/2 percent in the U.S.

Now in response, what often happens in those kind of severe recessions is there's a government policy response to try to protect existing jobs, try to make it easy for those who have lost their jobs to survive with unemployment benefits and whatnot. So you make it very difficult for firms to fire workers. You compensate those who lose their job very well.

And that's pretty much what Europe did in the response to these problems in the 1970s. So we're just going to show you some data on this. So the black line here is the U.S. unemployment rate from 1960 to 1980. There is Germany well under 4 percent for 20-something years. There's France, again, very low. Italy, below the U.S. for almost the entire 20-year period. And the same was true for the U.K.

So for 20 years, we looked like the terrible country that couldn't create jobs compared to Europe. Then a bunch of things happened, in large part, some of it policy-induced. Okay? And I'm going to show you that our unemployment rates came down. And because of a lot of the stuff Europeans put in place in the early 1980s to deal with, for them, what was very high unemployment, it did not. And so the cautionary tale is, are we falling into the same trap? By trying to help existing workers and help those who've lost his job, are we creating incentives and policies that make things worse? And this was the issue about the unemployment compensation, which I think that slide must have vanished out of my talk.

But here's what happened. So here's the U.S. again. As you can see, we hit—ah, this is a different slightly dataset—nearly 10 percent. It slowly comes down over the 25 years. Germany went up and stayed up. It never came back down till recently. Okay? Now these are different measures. There's various measures of unemployment in these countries. There's France. There's Italy. There's the U.K. So through most of this last 25 years, these countries had very high unemployment rates compared to the U.S. And so this was a big concern in Europe of, "What do we do? Are we going to have to permanently live with this high unemployment rate?"

You could see that if you were France, you might keep your interest rate at zero for 20 years. If you were saying, "Until unemployment gets back down to 7 percent, we're not going to raise the interest rate off zero," you'll be there for 20 years. Okay? And that's the trap we're trying to—we want to make sure we don't get into by tying ourselves to a potential unemployment number. Okay, this is President Bullard's argument. We want to be careful, because if Europe had done that, they would have been stuck in these situations for 20 years.

So I'll kind of conclude. I think I'm fairly close to being on time. So the Great Recession was very severe. It's not—even though unemployment didn't get as high as '81, '82, we've had very high unemployment for a long time, and the duration of unemployment is getting worse. We see some jobs opening up, but we don't see a lot of aggressive hiring being done, so we're not seeing unemployment rates come down.

Employment has not responded to very aggressive monetary and fiscal policies, which has led some people to say either you can't do anything or you have to do twice as much. I don't know what the right answer is, but we're kind of in that situation right now and that we want to be very cautious about saying, "Unemployment's high. We can get it down to 6 percent if we just do a bunch of stuff," and then it never comes down and we get stuck in this very high unemployment situation for a very long period of time. And I'll stop there.