A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



Jobs will grow in 2010, but then what?

By Lakshman Achuthan and Anirvan Banerji

Despite modest January job losses the good news for job seekers is that after a brutal recession that swallowed stimulus packages whole with barely a burp, the business cycle is finally your friend in 2010.

The reason the economy on Main Street feels so dismal is that while the revival is well underway, sustained job growth hasn't happened yet. Just like when you take a headlong dive into the deep end of a pool, you kick off the bottom and start climbing quickly, but there's the inevitable moment of doubt just before you break the surface.

With 5.7% GDP growth in the fourth quarter of 2009, following 2.2% in the third quarter, this recovery is already stronger than the last two. We are also on the cusp of sustained positive job growth only a couple of quarters after the end of recession. That's just one-third of the 21 months it took for job growth to resume after the 2001 recession.

Still, recovering is a far cry from recovered. And while the economy will certainly get better in 2010, the real problem is the long-term outlook for jobs.

Since World War II, there has been a clear easing pattern in the trend rate of economic growth during expansions, culminating in the 2001-07 expansion, which showed the slowest average growth on record -- especially in terms of jobs. Meanwhile, the "great moderation" of business cycles once extolled by many economists, including Fed Chairman Ben Bernanke, is history. Few expect that, following a vicious economic downturn and gigantic amounts of stimulus, the economy will coast smoothly back to moderate and steady growth. Rather, such extremes are likely to boost business cycle volatility.

The convergence of these two trends -- the shriveling strength of expansions and bigger cyclical volatility -- virtually dictates more frequent recessions punctuated by shorter expansions. In plain English, business cycles are back with a vengeance.

Because longer economic expansions are needed to steadily erode unemployment over a period of many years, a key takeaway is that in the coming decade more frequent recessions will repeatedly abort downswings in unemployment. That's a huge problem for the job market.

To make matters worse, it takes long expansions to make significant inroads into long-term joblessness (lasting over six months), which now represents 40% of total unemployment. In contrast, frequent recessions tend to keep boosting the long-term jobless rate.

Between 1969 and 1982, for example, we had four back-to-back recessions during a period of high cyclical volatility. As a result, the long-term jobless rate, which was cut down to a miniscule 0.14% by the long 1961-69 expansion, soared above 2.5% after the end of the 1982 recession -- an 18-fold increase.

That same long-term jobless rate is now at 4.1%, fully 29 times higher than what it had been four decades ago. If we get short expansions interspersed with frequent economic contractions, that number will move much higher. The bottom line is that we badly need a long expansion to heal the damage from the Great Recession, but we are unlikely to get one unless the economy's trend growth turns back up after decades of decline, and the "great moderation" of the business cycle stages a comeback.

Before the recent recession, Chairman Bernanke used to extol the great moderation, claiming, in effect, that it was the Fed's policy-making skill that had made it possible. All the while, the Fed kept making egregious policy errors, blowing serial bubbles in a misguided effort at reducing recession risk. The reality is that, while it staged a spectacular rescue of the economy from a potential depression, the Fed doesn't seem to have a good handle on when to tighten or ease monetary policy going forward.

Some consolation comes from the fact that past performance does not dictate destiny, and extrapolation from past patterns is not a reliable forecasting method. It is at least conceivable that either enlightened policy measures, or good luck, or both, will result in a more benign scenario than we have described.

The silver lining is that the task, while enormously difficult, is actually quite clear. It's not enough to advocate policies that would raise the average pace of expansions. More importantly, the Fed must do better in timing its actions, so that it helps to actually smooth out the business cycle instead of letting it spin out of control.