September 22, 2023

Economix Blog: Labor Force Participation Is Not Coming Back

Don’t worry about labor force participation. It’s not coming back.

That’s the conclusion of a new piece of economic modeling by the respected St. Louis firm Macroeconomic Advisers. And, if true, it has important implications for the Federal Reserve’s conduct of monetary policy over the next few years. Specifically, it means the monthly pace of job creation so far this year is ample to push the unemployment rate below 6.5 percent by mid-2015.

Let’s take a step back. Lots of people lost jobs during the Great Recession. In the aftermath, the great surprise has been how few are looking for new jobs. Labor force participation, the share of adults working or trying to find work, has stagnated at about 63.5 percent, almost three percentage points below the pre-recession level.

The unemployment rate has dropped almost entirely because of this decline in labor force participation. In other words, it has not fallen because people are finding jobs. It has fallen because fewer people are looking for jobs.

The question is whether that’s a permanent condition. Some economists say that people who have stopped looking for jobs will start looking again as economic conditions improve. If that’s true, it probably means that the Fed should be trying harder to stimulate the economy, because the current pace of job growth would not suffice to return unemployment to normal levels any time soon. As people finding jobs poured out of the unemployment pool, others would be pouring into the pool, keeping the level of unemployment unacceptably high.

Macroeconomic Advisers says, however, that participation is unlikely to increase. Yes, some people will start looking for jobs. But it predicts that will be offset by other trends, like the aging of the population into retirement.

It also points to the growing popularity of federal disability benefits, a program many researchers say is functioning as a safety net for people who can’t find jobs – except that it tends to remove them from the workforce on a permanent basis.

In effect, the model suggests that the Fed is right to focus on the unemployment rate as it decides how long to pursue its various stimulus campaigns.

If the model is right, further declines in unemployment will reflect job growth, not declines in participation. It will mean that things are actually getting better.

At the same time, if the model is right, the recovery will only go so far. Participation is in long-term decline, and the Fed can do nothing about it.

If the economy adds an average of 170,000 jobs a month over the next two years – well below the 200,000 per month pace so far this year – the unemployment rate will fall to 6.5 percent by mid-2015. The Fed’s chairman, Ben S. Bernanke, said yesterday that he thought the rate should end up around 5.6 percent.

We’ll have less unemployment, and less employment, and that will be that.

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Political Economy: The Euro Zone’s 2nd Chance to Clean Up Banks

One reason the euro zone is in such a mess is that it has not had the courage to clean up its banks. The United States gave its lenders a proper scrubbing, followed by recapitalization, in 2009. By contrast, the euro zone engaged in a series of halfhearted stress tests that missed many of the biggest banking problems, like those in Cyprus, Ireland and Spain.

In recent years, Europe has started to address these problems on a piecemeal basis. But it is still haunted by zombie banks, which are not strong enough to support an economic recovery.

The European Central Bank now has a golden opportunity to press the reset button in advance of taking on the job of banking supervisor in mid-2014. It must not flunk the cleanup.

Mario Draghi, the E.C.B. president, is alive to the opportunity and the threat. His fear is that, even if the supervisor does its job properly, there will not be a safety net for troubled banks that cannot recapitalize themselves. This is why he called on governments last week to make an explicit commitment to provide such a “backstop.”

Mr. Draghi highlighted the contrast between the U.S. stress test, in which Washington committed to plug any balance sheet holes, and the last stress test conducted by the European Banking Authority in 2011, which lacked such a commitment by governments. The U.S. test started the American economy on the road to recovery; the European one set off a new phase in the crisis.

The moral is obvious: Without a safety net, shining a light on problems can provoke panic. The supervisor may as a result be tempted to continue sweeping problems under the carpet. The euro zone’s recovery would then be further delayed, and the E.C.B.’s credibility destroyed.

So far, governments have not responded to Mr. Draghi’s request for a backstop. In the meantime, the E.C.B. and the banking authority — which are working on different aspects of the cleanup — have many issues to clarify.

First, who exactly will review the banks’ assets? The E.C.B. does not yet have the manpower to do it. So it has to rely on national supervisors. The snag is that these supervisors could have an incentive to hide problems in their banks, so the cost of bailing them out is borne by the euro zone as a whole.

Mr. Draghi’s answer is to get supervisors to cross-check the balance sheets of banks in other countries — and to reinforce the audit’s independence by involving private-sector assessors. The latter suggestion originally provoked unhappiness in France. But at a recent dinner with central bank governors, Mr. Draghi pushed his solution through.

That still leaves the question of whether the E.C.B. can conduct a sufficiently in-depth review given that it wants to finish the whole process by next spring. It needs to figure out how likely loans are to turn sour and whether banks have taken adequate provisions against that possibility. About 140 of the euro zone’s top banks will be reviewed.

The E.C.B. should also look into whether lenders have used appropriate “risk weights” for their assets. A risk weight determines the size of the capital buffer a bank is required to hold. There is a widespread suspicion that many lenders are using artificially low weights to give the misleading impression that they are well-capitalized.

After the E.C.B. completes its review, the banking authority will conduct a stress test to check whether banks can survive a shock. This raises many other questions, on matters including how big a shock it will test; how much capital banks will need to have in this stressed scenario; and how long they will get to restock their capital if they fail the test. If the banking authority is too soft, the test will be exposed to ridicule in financial markets.

Yet another issue is whether capital shortfalls will be expressed as an absolute number — like €1 billion, or $1.3 billion — or as a percentage of risk-weighted assets. The last banking authority test plumped for the percentage method, with the disastrous consequence that many banks solved their capital problem by selling assets and stopping lending — and thus further crushing the economy. Ewald Nowotny, an E.C.B. council member, suggested to Reuters last month that this error would not be repeated.

Once all this is dealt with, the question then becomes who will provide a backstop in the event that a bank has a capital shortfall that it cannot fill itself, and its government has too much debt to help out.

One option would be for the European Stability Mechanism, the zone’s bailout fund, to inject capital directly into banks. But Germany seems to have rejected this.

The main alternative is that the stability mechanism should lend money to national governments, which could then inject it into their banks. That is what happened last year when Spain’s lenders got into trouble.

The snag is that this would add to the government’s deficit and debt. A partial workaround could be for the European Commission to ignore any capital injections when it determines whether governments are doing enough to cut their deficits. Without such forbearance, the countries could be forced into another round of growth-pummeling austerity measures.

With so many issues to resolve, there is a risk that Europe’s megabank cleanup will either be another damp squib or even create more damage. Having wasted five years failing to address the problem properly, the euro zone must make sure this does not happen.

Hugo Dixon is editor at large of Reuters News.

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Crop Insurance Swells Beyond Disaster Aid, Study Says

The study comes as lawmakers are preparing to work on a new farm bill, a spending bill passed every five years that sets the nation’s food and farm policy. The last farm bill was passed in 2008.

The study was financed by the Environmental Working Group, a Washington research group, and conducted by Bruce A. Babcock, an agriculture economist at Iowa State University.

Under the federal crop insurance program, farmers can buy insurance that covers poor yields, declines in revenue or both. Dr. Babcock said most farmers bought a combination of the two policies.

The result, he said, is that crop insurance has become more of a farm income support program than a system that protects farmers in times of disasters like the 2012 drought.

Taxpayers pay about 62 percent of the insurance premiums. The policies are sold by 15 private insurance companies, which receive about $1.3 billion annually in total from the government. The government also backs the companies against losses.

These subsidies drive up the cost of the program, Dr. Babcock said, with farmers buying higher levels of coverage than they otherwise would. He estimated that without the subsidies, crop insurance payouts during last year’s drought for the two largest crops, corn and soybeans, would have been just over $6 billion, about half of the $12 billion that the government actually paid.

As a result, the study found, many farmers made more money from insurance payouts during the drought than they would have from healthy crops.

“It’s good insurance and a good safety net,” Dr. Babcock said. “The question is, is there any justification for taxpayers to subsidize the costs?”

Crop insurance will be a major part of the new farm bill. Last year, lawmakers on the House and Senate Agriculture Committees passed legislation that would expand the crop insurance program by eliminating $5 billion a year in direct payments to farmers and farmland owners who receive government checks regardless of whether they grow crops, and diverting some of that money to crop insurance. The Senate passed its version of the farm bill, but the House bill was never brought to the floor for a vote.

Agriculture groups and farmers say the crop insurance program is crucial.

“The significant, widespread crop losses of 2011 and 2012 have clearly demonstrated the need for crop insurance protection and the public-private partnership of program delivery,” a coalition of farm groups wrote to members of the House and Senate Agriculture Committees in March.

The crop insurance program has drawn a wide range of criticism from those who say that the costs need to be reduced and that it benefits mainly insurance companies and large farmers.

Farmers’ net income for 2012 is expected to be $114 billion, down 3 percent from 2011 but still the second highest in 30 years. Crop insurance subsidies are set to cost more than $94 billion over the next 10 years, according to the Congressional Budget Office.

President Obama has proposed cutting crop insurance subsidies and reducing the amount paid to insurance companies, saving about $4 billion over 10 years.

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Economix Blog: Casey B. Mulligan: Millions Caught by the Social Safety Net


Casey B. Mulligan is an economics professor at the University of Chicago.

Despite the severe recession, relatively few people saw their living standards fall into poverty, thanks to the social safety net.

Today’s Economist

Perspectives from expert contributors.

According to the Center for Budget and Policy Priorities, the percentage of the United States population living in poverty increased by 0.6, to 15.5 in 2010 from 14.9 in 2007.

The poverty measure refers to resources available to families, accounting for the taxes they pay and subsidies they receive. Considering all that happened in the economy over those three years, 0.6 percentage points is quite a small change. Measures of the poverty rate typically change more than that over any three-year interval.

The study found that many people were technically above the poverty line in 2010, although their incomes were low, because they received government assistance like unemployment insurance, food stamps and refundable tax credits. The government assistance permitted them to have living standards above poverty, even while their market incomes were below the poverty line.

Were it not for government assistance, the study found, the recession would have pushed 4.2 percent of the population into poverty, rather than 0.6 percent.

One interpretation of these results is that the safety net did a great job: For every seven people who would have fallen into poverty, the social safety net caught six. Perhaps if the 2009 stimulus law had been a little bigger or a little more oriented to safety-net programs, all seven would have been caught.

Another interpretation is that the safety net has taken away incentives and serves as a penalty for earning incomes above the poverty line. For every seven persons who let their market income fall below the poverty line, only one of them will have to bear the consequence of a poverty living standard. The other six will have a living standard above poverty.

The safety net was not as effective before the recession began. As I explained in my last two posts, government assistance programs have not only supported more people but become more generous, thanks to changes in benefit rules since 2007.

Of course, most people work hard despite a generous safety net, and 140 million people are still working today. But in a labor force as big as ours, it takes only a small fraction of people who react to a generous safety net by working less to create millions of unemployed. I suspect that employment cannot return to pre-recession levels until safety-net generosity does, too.

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Letters: How the Debt Ballooned, and How to Deflate It

To the Editor:

“U.S. Has Binged. Soon It’ll Be Time to Pay the Tab.” (Fair Game, May 29) echoed what historians already know — that nations with empires to maintain soon run out of money to maintain them. It happened with Rome and the British Empire, and now it’s happening with our own.

Since Ronald Reagan was president, we have fought both our hot and cold wars by borrowing without having the money to pay for them. And we have starved the beast of government revenue by creating policies that transferred huge amounts of wealth to the wealthiest. This, in turn, has resulted in starving the biggest engine of our growth: the lower- and middle-income consumers who now have declining real incomes and wealth.

As developing countries begin to mature — and with notably less debt — they are becoming the engines of growth and will be its future dominant players.

Harlan Green

Santa Barbara, Calif., May 30

To the Editor:

How can the United States pay for its binges? We can count the ways:

Use pay-as-you-go budgeting, means-testing for all government assistance programs, sunset provisions for agencies and programs that have completed their missions. End pork-barrel item spending and stop paying farmers to not grow crops. Abolish corporate welfare subsidies in the form of favorable tax code deductions. Start a real campaign against waste, fraud and abuse. And the list goes on.

If we don’t take action, not only the poor, but also our vast middle class will suffer. And if we kick the can to future generations, there will eventually be no safety net for anyone. Larry Penner

Great Neck, N.Y., May 29

Letters for Sunday Business may be sent to

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Economic View: It’s 2026, and the Debt Is Due

The following is a presidential

address to the nation — to be

delivered in March 2026.

MY fellow Americans, I come to you today with a heavy heart. We have a crisis on our hands. It is one of our own making. And it is one that leaves us with no good choices.

For many years, our nation’s government has lived beyond its means. We have promised ourselves both low taxes and a generous social safety net. But we have not faced the hard reality of budget arithmetic.

The seeds of this crisis were planted long ago, by previous generations. Our parents and grandparents had noble aims. They saw poverty among the elderly and created Social Security. They saw sickness and created Medicare and Medicaid. They saw Americans struggle to afford health insurance and embraced health care reform with subsidies for middle-class families.

But this expansion in government did not come cheap. Government spending has taken up an increasing share of our national income.

Today, most of the large baby-boom generation is retired. They are no longer working and paying taxes, but they are eligible for the many government benefits we offer the elderly.

Our efforts to control health care costs have failed. We must now acknowledge that rising costs are driven largely by technological advances in saving lives. These advances are welcome, but they are expensive nonetheless.

If we had chosen to tax ourselves to pay for this spending, our current problems could have been avoided. But no one likes paying taxes. Taxes not only take money out of our pockets, but they also distort incentives and reduce economic growth. So, instead, we borrowed increasing amounts to pay for these programs.

Yet debt does not avoid hard choices. It only delays them. After last week’s events in the bond market, it is clear that further delay is no longer possible. The day of reckoning is here.

This morning, the Treasury Department released a detailed report about the nature of the problem. To put it most simply, the bond market no longer trusts us.

For years, the United States government borrowed on good terms. Investors both at home and abroad were confident that we would honor our debts. They were sure that when the time came, we would do the right thing and bring spending and taxes into line.

But over the last several years, as the ratio of our debt to gross domestic product reached ever-higher levels, investors started getting nervous. They demanded higher interest rates to compensate for the perceived risk. Higher interest rates increased the cost of servicing our debt, adding to the upward pressure on spending. We found ourselves in a vicious circle of rising budget deficits and falling investor confidence.

As economists often remind us, crises take longer to arrive than you think, but then they happen much faster than you could have imagined. Last week, when the Treasury tried to auction its most recent issue of government bonds, almost no one was buying. The private market will lend us no more. Our national credit card has been rejected.

So where do we go from here?

Yesterday, I returned from a meeting at the International Monetary Fund in its new headquarters in Beijing. I am pleased to report some good news. I have managed to secure from the I.M.F. a temporary line of credit to help us through this crisis.

This loan comes with some conditions. As your president, I have to be frank: I don’t like them, and neither will you. But, under the circumstances, accepting these conditions is our only choice.

We have to cut Social Security immediately, especially for higher-income beneficiaries. Social Security will still keep the elderly out of poverty, but just barely.

We have to limit Medicare and Medicaid. These programs will still provide basic health care, but they will no longer cover many expensive treatments. Individuals will have to pay for these treatments on their own or, sadly, do without.

We have to cut health insurance subsidies to middle-income families. Health insurance will be less a right of citizenship and more a personal responsibility.

We have to eliminate inessential government functions, like subsidies for farming, ethanol production, public broadcasting, energy conservation and trade promotion.

We will raise taxes on all but the poorest Americans. We will do this primarily by broadening the tax base, eliminating deductions for mortgage interest and state and local taxes. Employer-provided health insurance will hereafter be taxable compensation.

We will increase the gasoline tax by $2 a gallon. This will not only increase revenue, but will also address various social ills, from global climate change to local traffic congestion.

AS I have said, these changes are repellant to me. When you elected me, I promised to preserve the social safety net. I assured you that the budget deficit could be fixed by eliminating waste, fraud and abuse, and by increasing taxes on only the richest Americans. But now we have little choice in the matter.

If only we had faced up to this problem a generation ago. The choices then would not have been easy, but they would have been less draconian than the sudden, nonnegotiable demands we now face. Americans would have come to rely less on government and more on themselves, and so would be better prepared today.

What I wouldn’t give for a chance to go back and change the past. But what is done is done. Americans have faced hardship and adversity before, and we have triumphed. Working together, we can make the sacrifices it takes so our children and grandchildren will enjoy a more prosperous future.

N. Gregory Mankiw is a professor of economics at Harvard.

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