Monday, May 4, 2015

Employment Preview and Real Estate Loans

Continuing claims of unemployment insurance have resumed a strong declining trend.  So, I thought it would be useful to revisit some of my employment graphs.

Here is the graph that compares insured unemployment to total unemployment.  There is a typical shape of this relationship over business cycles and over time.  The unemployment rate has remained elevated as insured unemployment has tested all-time lows, partly due to a contingent of very long term unemployed (with unemployment durations of over 2 years) and partly due to a persistently elevated level of uninsured unemployment among shorter durations.  For a while, there was a pretty linear trend of about 0.05% of the unusual long term unemployment declining each month.  It seemed like this had possibly leveled out.  But, as a close-up view of this graph shows, there was one divergence in July 2014 of about 0.3%, where the expected unemployment rate went down and the reported unemployment rate went up.  In the months before and after that, reported unemployment has actually followed very closely with the unemployment we would expect from continued claims.  If we add 0.3% to the modeled rate this month, that gives us an expected unemployment rate of 5.3%.

(On each of those graphs, the April insured unemployed level is as reported, and the 5.3% unemployment rate is manually input to show where this relationship would fall for April if unemployment comes in at 5.3%.)

Unemployment at the longer durations has been declining at a healthy pace over the past couple of months.  This pairs nicely with the recent decline in continued claims as a strong statement about the breadth of strength in the labor market.

In addition, here is the model of unusual long term unemployment which confirms the trend that has continued in the insured vs. total unemployment relationship.  This continues to converge back to historical norms as long term unemployment declines.

Here we can also see the persistent unemployment level at lower durations.  Insured unemployment is near all-time lows, but unemployment duration at shorter durations is still elevated enough to inflate the expected long term unemployment levels.  The expected level of long term unemployment should be down to 0.5% by now compared to recent recoveries, but it is still at 1%.  And, on top of that, there are another 0.6-0.7% of workers at very long durations.  It appears that the very long term unemployment has a shorter "half-life" than the persistent short term unemployment.  Some of the increased durations in short term unemployment are demographic in nature, so this may bottom out in the 0.7-0.8% range.  But, those same demographic trends should pull down employment turnover in general, so that the unemployment rate should still be capable of reaching 4% or less if the recovery is allowed to age.

Just as a clarification, I don't consider a strong labor market to be inflationary.  I think a strong labor market tends to coincide with strong real economic growth and this is related to rising real interest rates and rising real wages.  These trends tend to make the Fed pro-cyclical, since the neutral rate rises while the Fed's target rate stays in place.  It is that lag in Fed rate setting policy that causes strong labor markets to appear to be inflationary.  If there is any truth to this conjecture, this is another reason why using target interest rates as the policy tool is not optimal.  In any case, I think that falling unemployment and related rising wages (which come from reduced frictions in the labor market, not from some sort of wage inflation) will be interpreted as inflationary, and will cause the Fed to raise the target rate.  I don't think the exact target of the Fed Funds rate is that important right now.  If the housing market wasn't hobbled, the neutral short term rate would already be well above the current Fed Funds rate.  If mortgages don't expand, there won't be any inflation.  If they fail to expand, the rate at which short rates top out will be lower.  If they do expand, then the peak rates will be higher, both from inflation and from real expansion.

The weekly indicator of closed end real estate loans at commercial banks has taken a breather for a couple of weeks.  (This shows seasonally adjusted <blue> and not seasonally adjusted <red>.  Seasonal adjustments are in flux right now, so both series have a monthly cycle right now.)  The April levels are about even with March levels.  It would be nice to see a good jump over the next week or two.



    My first blog post in two months. What do you think conceptually Kevin?

    1. Clever. I like your inclination to think outside the box. But, I think it might be too clever by half. The substitution goes the other direction. Bonds can't be used as cash so much as cash gets used as bonds. The problem is that cash, which would normally be used to bid up the price of goods & services, instead gets parked at a bank. So, even though this thing that looks like currency is out there, much of it isn't being used as currency. It's being used as a short term bond instead. Substitution doesn't tend to happen in the other direction. At low interest rates, people don't pay store clerks with savings bonds or stock certificates.

      When the supply of currency has been curtailed, which is the opposite of the events you are positing, substitution can go the other way. Way back when, bank clearinghouses would issue IOUs or scrip to get through liquidity crises. More recently, I think some of the later increases in mortgage debt and other credit in 2006 and 2007 were an attempt by households use non-cash assets as sources of new cash when the Fed was starving the market of currency. Of course, the Fed viewed this as unsustainable risk-taking, and just turned the screws tighter until there were no sources of liquidity remaining.

    2. Also, it seems pretty empirically clear that monetary expansion becomes less potent at low rates, not more potent.

    3. I think there are a few theoretical holes in the "parking cash in bank accounts" story. Bonds are inherently more risky than cash, especially as the duration gets longer (yields on Euro bonds have gone negative as far as 6 years out, right?). If cash and bonds are functionally equivalent in terms of yield then you wouldn't expect there to be much demand for bonds at all, and rates would have to rise (or the CB would have to buy up virtually all issuance). I don't believe that we have seen that throughout QE as auctions were heavily oversubscribed at low rates frequently.

      Additionally the traditional explanation for why lowering interest rates is stimulative is a combination of lower costs for borrowing/investing combined with lower yields on safe returns cause them to accept more risk. SS has a story about people wanting to hold X in cash and then when they have that they go out and spend/invest the rest. If people treat bonds and cash roughly the same, those bonds can satisfy their desire to hold cash to some extent (even if they don't actually pay bills with those bonds).

    4. I think the traditional explanation reasons from a price change.

      QE involved the Fed buying bonds and, in effect, selling the banks short term loans. Long term rates tended to rise during QEs.

      This is where expectations would be helpful. If the Fed had credibly targeted high inflation or higher NGDP, then there would have been less demand for near cash securities and the monetary base would have been more inflationary.


    5. The last line here is very speculative. Record (non wartime) amounts of Treasuries were bought when rates were at or near zero. Hundreds of billions went into zero return assets that carried IR increase risk. Assuming that the prospect of lower return would have significantly dampered this effect is not a given.

    6. I think the idea is that inflation comes from an increased propensity to consume when it becomes more expensive to save or hold cash.

  2. BTW I agree with your second point about monetary stimulus being less effective. This post was about the logical implications of the liquidity trap, not a defense of it. The fact that reality is at odds with the theory is a blow against the LT.

    1. I think the problem with the liquidity trap idea isn't that it doesn't explain tendencies in monetary policy. The problem is that it is used to argue against monetary policy, when aggressive monetary policy not only can overcome it, but actually makes it less constraining at some point.

      I think durations may matter more in reality than they do in your conjecture. I think that's why Operation Twist wasn't very effective at creating inflation, because the Fed was trading bonds for notes, basically. Neither serve as a very effective substitute for cash. So it wasn't as effective as trading bonds for reserves, even though the bonds for reserves trade was less potent than it would be at higher rates.

      I haven't looked at the research on this, but I suspect that the demand for cash or reserves is very convex - that it is extremely high when short term rates are near zero, but drops off quickly even at pretty low rates. I don't think there was an unusual jump in the monetary base when the Fed Funds Rate was at 1% in 2003.