Employment Bounceback?

From Peter Hooper, Torsten Slok, Christine Dobridge, “Robust growth needed to avoid jobless recovery,” Deutsche Bank Global Economic Perspectives (Dec. 9) [not online]:

Okun’s Law is an empirical regularity that holds that for
every one percent decline in GDP growth relative to potential,
the unemployment rate will increase by about 1/2 percentage
point….To consider
the extent to which there may have been some excessive
layoffs during the downturn, Charts A1 and A2 show the
relationship between changes in employment and changes
in real GDP, with GDP lagged one quarter. Both charts
show that the change in employment during this recession
was noticeably more negative than the standard Okun’s
Law regression would predict. On the assumption that
historical relationships reassert themselves, we surmise
that employment could bounce back more strongly during
this recovery…

Below is my version of Figure A2, where I’ve used a sample over 1967q1-09q3:


Figure 1: Scatterplot of annualized growth rate of q/q nonfarm payroll employment against annualized growth rate of q/q GDP growth, lagged one quarter (blue cirles), and OLS fit (dark blue line). Red circles for 2008q1-09q2, and OLS fit (purple line). Growth rates calculated as log-differences. Source: BEA and BLS via FREDII, and author’s calculations.

The idea is that with the lower intercept during the recession period, employment growth will have to compensate later on. This would be represented by an upward shift of the “long term” Okun’s law.

This is in some sense substantiated by the fact that the long run that Okun’s law relationship between employment and lagged GDP growth is even stronger, but with a downshifted intercept, over the 1990q3-09q3 period.


Figure 2: Scatterplot of annualized growth rate of q/q nonfarm payroll employment against annualized growth rate of q/q GDP growth, lagged one quarter (blue cirles), and OLS fit (dark blue line). OLS fit for 1990q3-09q3 (pink line). Growth rates calculated as log-differences. Source: BEA and BLS via FREDII, and author’s calculations.

Note that implied growth rates are the same only if q/q annualized GDP growth rates exceed approximately 6%.

Some additional observations. First, there are several different Okun’s Law floating around in the literature. Another, perhaps more popular, alternative links the unemployment gap (in percentage points) to the output gap (in percentage gaps) (see here). Second, this set of estimates is partly consistent with the error correction model (ECM) approach adopted in this post. In essence each regression line shown in the figures drops the long term cointegrating relationship between the (log) level of employment and (log) level of GDP.

I’ll observe that while the error correction approach I used in that post can partly accomodate the “bounceback” effect — the deviation from the long term cointegrating relationship adds some extra upward pressure on the growth rate of employment — but doesn’t do so fully. To do that, a threshold ECM would have been necessary.

19 thoughts on “Employment Bounceback?

  1. RicardoZ

    I have my differences with Frank Shostak at the Mises Institute but let’s have some fun. Here http://mises.org/daily/3898 is Shostak’s Austrian analysis of GDP which, according to Okun should be reflected in changes in unemployment.
    “The strong money pumping from August last year until August this year is likely to manifest itself in the strengthening in the growth momentum of GDP. Given the still-subdued price indexes, this is likely to result in a visible strengthening in the real-GDP rate of growth. (Remember, this is on account of misleading deflators).”
    “As a result of a recent, steep fall in the growth momentum of AMS [AMS is defined by Shostak as currency plus demand deposits with commercial banks and thrift institutions plus saving deposits plus government deposits with banks and the central bank.], we forecast that the growth momentum of real GDP will come under pressure in Q2 next year. (Year on year, the rate of growth is forecast to rise to 1.7% in Q1 next year before falling to −0.2% in Q4). Again, please note that real GDP has nothing to do with the true state of the economy.”
    I love that last line.

  2. ppcm

    A cheerful linear projection,the economies have been on financial engineering for eight years now.
    Engineering is still not at the driving seat.

  3. Cedric Regula

    The conclusion(admittedly layman) I keep coming to is that we are going to have to let old people retire. But the obstacle in the way here is that neither old people nor the government can afford it. Go figure.
    Maybe if we can do something with inflation and fix the problem? I like the one where Congress borrowed the Social Security trust fund and paid a 2% non-market interest rate for decades. But the payout was cola adjusted. Here, inflating our way out of the debt worked!
    I also don’t see how anyone can believes we can go back to boom year levels of employment. We aren’t going to be building a million new homes year, or getting $600B-700B in MEW a year to spend. For some period of time the government is acting as the provider of demand of last resort, and it’s anyone’s guess when the well runs dry there.
    And even if we get GDP to increase, it will be due to things we don’t really like spending money on, like health insurance(our cost reduction reform costs about a trillion), carbon taxes(or cap and and trade transaction fees), any costs with doing anything real about lowering our carbon based infracture and maintaining supply of energy(not to mention international competitiveness) , the WTO says we can put import duties on countries that don’t comply with GW rules so import prices could go up, eventual higher interest costs (plus to moderate this we will need to come up with new CPI index if import prices go up), and a larger tax transfer from private to public sector whenever the government(or treasury market) decides it’s necessary to firm up the weak association between government spending and tax revenue.
    Economics really sucks.

  4. cthomson

    The data I’ve seen suggests that unemployment is predictably falling hardest on the young unskilled and semi-skilled. What about taking a longer term approach to this problem that might have some up front benefits as well?
    Pay every female citizen who already had three live births $100,000 tax free upon being sterilised. Accepting this payment would be entirely VOLUNTARY and not eugenics. It is a fair bet that much of this payment would be promptly spent.
    Since college educated women average around two children by their own choice, this program, if widely taken up, would tilt us away over time from churning out unskilled, and often unwanted, kids. Judging by Freakonomics it should reduce crime, as well. Plus improve our high school graduation rates. And be cheap compared to the cost of one stimulus job.

  5. Carlomagno

    I agree with Credric Regula: until someone comes-up with a plausible source of strong employment growth for the US economy, these statistical exercises sound hollow.

  6. Menzie Chinn

    CoRev: Yes, because if people can spend a whole weekend on party-crashers at the WH, and the travails of a famous golfer, they can waste brain cells on that hacking incident.

  7. Esteban

    R-square = 0.37? It’s amazing what will pass for a “law” in economics. How about Okun’s Conjecture?

  8. Menzie Chinn

    Esteban: Q/q changes are hard to predict. Using y/y changes (on quarterly data) yields a Adj.Rsq of 0.64. Over the 1975-09 period, using the unemployment rates and CBO defined output gap, one obtains an Ad.Rsq of 0.86 (using quarterly data).

  9. Jim Blair

    In all of the discussion about the current “jobless recovery” I have seen no mention of the 25% increase in the Federal minimum wage that has been instituted in 3 steps starting in 2007. It has been increased each summer in 2007, 08 & 09.
    Past studies over 50 years have demonstrated either a decrease in new hires or an actual increase in unemployment, typically beginning about 4 months before the minimum wage increase takes effect.
    Basic economic theory would predict a decrease in demand if there is an increase in price, whether for cigarettes, gasoline, or workers. Why has no one (or no one that I have read) even noted the minimum wage increase and suggested a connection to the lack of new jobs?

  10. Jim Blair

    Hi Carlo:
    So Krugman say in effect that the higher the mandated minimum wage the more workers he expects to be hired. But is he confusing averages with the margin?
    Employers hire based on the marginal cost.
    And they consider the cost of a (typically unskilled) worker vs. the cost of a machine (like a self checkout station) or just having the customer do the work (like self serve gasoline pumps where you pay by credit card with no contact with a clerk). I recall seeing more of these recently. They are likely good for “the economy” but not so good for teenagers looking for that first job.
    At any rate PK’s is a theory and one I consider unlikely. But how about a look at actual studies?

  11. Carlo

    Your suggesion was that if the minimum wag was lower than it currently is, i.e. if the government mandated a cut in the minimum wage, aggregate employment would increase.
    There is simply no way this would happen in the current economic context: a cut in the minimum wage would decrease household income and demand. While it may increase, corporate income the only way that could result in more jobs is if corporations increased investment. But why would they do that in the current economic context? They won’t unless there is a credible perspective of increasing demand down the line. Moreover, the impact of the cut in household income on demand may well outweigh the impact of the inreasing invesment, especially since it the former would be concentrated in lower income households, whose margial propensity to consume / income elasticity of consumption is steeper than the average IIRC.

  12. Jim Blair

    Carlos (and other readers, if any ;-):
    You are looking at this backwards. The government does not “mandate” a reduction in the Federal minimum wage. And if it did, that would not necessarily reduce the wage of any current employee.
    My original comment on this was a suggestion that the 25% INCREASE in the minimum wage starting in 2007 should be examined as a factor in the current “jobless” recovery–if not also in the recession that followed it.
    Your assumption (and Krugman’s as well) seems to be that workers will be paid more when the minimum wage is increased, with no consideration of the possibility that fewer new workers will be hired as a result. Of course new hires did decline after the increase (not just after this increase but also after past increases). Your “current economic context” came after the recent increase. The only question: was that merely a coincidence?
    As for “raising wages” you know that not all workers and jobs are “protected” by the minimum wage. One of the more interesting studies I have seen was the impact on workers not covered by the minimum wage law. Their wages were found to decline after an increase. That was assumed to be because of increased competition from would-be workers unable to find jobs in the protected industries.
    And do you agree that “theory” alone cannot resolve this issue? That data is also needed to resolve the predictions of conflicting theories?
    I showed you some of mine. Now you show me yours.

  13. Carlo

    @Jim Blair: my point is that an abstract debate about the impact of a hange in the minimum wage is poitnless. You need to look at the issue in a given economic context. From a policy perspective, we live in the here and now.

  14. Jim Blair

    I am puzzled by your last. Do you mean that economic theory cannot evaluate the effect of policies or laws?
    Or do you mean that it is useless to point out the adverse consequences of laws once politicians from both major parties have decided that those laws are useful to support because that gains more votes than opposing them, no matter the actual effects of the laws?
    When I was in school and for decades after, economists were not afraid to publish studies on the adverse effect of minimum wage laws on employment. The issue then was still subject to discussion. More recently, and especially since G.H.W. Bush backed off of his first veto and signed an increase, all consideration of alternative ways to assist the working poor were dropped, and both major parties now support the minimum wage. As one congressman said on TV, voting for increasing the minimum wage is good politics because that way he can be seen as “giving a pay increase to millions of voters without it costing any one any thing”.
    And it would seem that is the policy perspective we live in here and now.

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