Although the Fed announced months ago it is considering pulling back its purchase of assets, unemployment remains historically high. What, if anything, can the government do to get people back to work?
In order to determine the right policy prescription, first we must diagnose what’s causing unemployment. Is the high unemployment due to low demand from the recession, known as cyclical unemployment, or has the world changed and jobs are not coming back, known as structural unemployment? Most likely it’s both. It is impossible to know precisely how much new unemployment is structural and how much is cyclical. This uncertainty has sparked a contentious debate about the nature of unemployment that has been raging since the start of the recession, and lately seems to be hardening into absolutism. The cyclical camp fears that acknowledging an increase in structural unemployment will be used as an excuse to support tightening monetary policy, and gives the government a pass on fixing unemployment. But actually, saying all unemployment is cyclical is what lets the government off too easy. Structural unemployment can be helped with policy, but the solutions take more political will, creativity and leadership. We can lower the structural rate by changing tax incentives to encourage mobility, both job and location, and building a wealth cushion to finance productive job transitions.
If unemployment is cyclical then all the government has to do is reignite demand. For example, if people aren’t buying much then firms don’t produce or sell as many goods, and therefore employ fewer people. Typically to compensate for recessions, monetary policy makers lower interest rates. This encourages people to buy more or firms to expand. That creates more demand and firms hire again. If the Fed creates more inflation, which lowers real wages, then firms can hire more cheaply.
Or the problem might be structural. Structural unemployment is often poorly understood because economists use several different definitions for it. It is often called the natural or permanent rate of unemployment — though there is nothing permanent about it; it varies over time. It is also known as the non-accelerating inflation rate of unemployment, meaning rates can be lowered and inflation created, but there will be little impact on unemployment. If all unemployment is structural and the Fed tries more expansion, all you get is high unemployment and more inflation.
An increase in the structural unemployment rate may be caused by several different factors. Employers may want to hire people, but can’t find people with the necessary skills. Or if unemployment benefits are higher than what people can earn working, some people will prefer not to work. That is probably not a large factor in America today, but it explains why some European countries like France and Germany had a higher structural rate than the U.S., more than 8 percent before the crisis. Labor market reforms in Germany, which enhanced flexibility and encouraged work, are credited with lowering its structural rate. Another factor could be if employers must pay higher compensation, including salary and benefits, than they’d like to their workers. Geographic immobility, if job seekers can’t move to where the jobs are, is another contributor. The definition can also be broadened to account for economic well-being. Suppose a laid-off manufacturing worker can only find a job in a fast food restaurant or part-time contract work. He no longer counts as unemployed, but a structural change undermined his economic security and an otherwise productive worker is underemployed.