Understanding the Labor Market in a Deflationary Economic Context

Understanding the Labor Market in a Deflationary Economic Context Paul E. Harrington Center for Labor Market Studies Northeastern University Boston, Massachusetts January 2009

A Thumbnail Sketch of the Economic Crisis An Economy out of Balance Total GDP 2000 to 2007 $92.5 Trillion Total Purchases of G&S $97.0 Trillion Difference -$4.5 Trillion

How did we purchase more than we produced? Purchased Goods from Overseas U.S. Balance of Trade Deficit increased by about $4.5 Trillion

How did we pay for excess consumption? Household debt doubled by $6.8 trillion Between 2000 and 2005 average home price doubled Almost half of this debt secured by mortgages Savings rate fell to zero

A Housing Bubble “Market Values Fluctuate: Debt is Forever” Unlike equity bubbles housing bubbles quickly convert to spending Banks “make your home work for you” Out of $6.8 Trillion increase in debt, $4.2 Trillion NOT spent on housing Consumer electronics/autos/trucks

Who lent us the money? China, oil producers including Russia and Saudi Arabia These nations purchased U.S. Treasuries-safe and secure Held assets in U.S. banks—swelling domestic banking reserves

How did this fuel borrowing and spending? • Large reserves fueled rapid growth in money supply • Fractional reserve lending system meant that growth in reserves resulted in large growth in money supply via the money multiplier –result was low interest rates

Federal Reserve Response Fed did nothing Greenspan: World has entered into a “new economic paradigm (rejection of liquidity preference theory and acceptance of the efficient market theory) Prices set in asset and housing markets are ‘correct’

Fed continued Absence of inflation over 2000 to 2005 led to fed to inaction Fed supported rising asset prices Permitted rapid expansion in money supply and declining real interest rates Fueled further increases in housing and stock markets (asset inflation)

How did housing bubble burst? Mortgage loans made to people with no hope of making payments Sub-prime Home equity loans based on assumption of perpetually rising housing prices Teaser rates Home values collapse -down 25 Percent since mid 2006

What’s different about this downturn? Rise in asset values are based on financiers making increasingly risky loans Banks developed new ways of sell off these risky loans into world markets CDOs Credit Default Swaps Estimated $30 Trillion losses in wealth across the world

Problem is now well beyond mortgage backed securities and housing market Commercial lending Credit card lending Auto lending All suffering rising default problems So banking system sharply reduces lending—money multiplier collapses—liquidity trap

Financial meltdown has led to deflation Deflation is a downward pressure on prices that sharply reduces the level of output, employment and income Deflation is a self-reinforcing downward spiral based on future expectations about prices that reflect overall economic conditions

What is the Current Economic Situation? • Global Demand for Goods and Services Falling Sharply • 4th qtr GDP in Industrialized Nations fell 6 to 7 Percent annual average pace. • 1st qtr 2009 GDP is expected to fall at same pace.

Asset Values Continue to Decline • Sharp decline in housing values—25 percent decline in mean price level • Additional 20 percent decline expected this year • Equity assets declined by 50 percent since peak • Estimated that about 1/3rd of value of world wealth wiped out last year • U.S. wealth value fell by about $11 trillion in 2008

Deflationary Cycle • Decline in value of assets leads to • Increased desire and intensity of savings—depress demand growth • Increased savings rate (now over 5%) • Decreased consumption (retail sales contracted by 28 % apr in 4th qtr 2008) • Corporate profits fall sharply—huge banking sector losses-rise of zombie banks • Continuing reductions in consumption make expanding profits next to impossible

…GDP Falls • Declines in C+I results in GDP declines • Profit declines result in cut-backs in production • Lay-offs rise sharply, job vacancies fall sharplhours • Accelerating rate of job losses • Rising unemployment • Sharp reductions in hours of work per week, increase in part-time work for economic reasons

…Decline Accelerates • Employment losses lead to real income declines • Households make effort to raise savings rate • Expectations of future prices of asset values fall—decrease purchases of assets-further reduces their price • Values of housing declines • Value of equities declines • These paper declines feed back into a new round of cutbacks in the real economy- an adverse feedback loop or deflationary spiral

Phases of Downturn • August 2007- March 2008:market cap of banks insurance companies begins to erode Monthly losses in value average $150 billion (Bear Stearns 3/2008) • March to Sept 2008: Losses mounted to $260 billion per month (Lehman bankruptcy 9/2008) • September 2008 to January 2009: Losses in value of banks and insurance companies explodes– average decline of $ 660 billion permonth • Asset write downs in global finance about $5 trillion

Job Market Developments • Recession begins in December 2007 Payroll employment declines average 137,000 per month over the period • August to November job losses accelerate to 436,000 per month • December to February job losses in U.S, average 662,000 • Expectations of this months reports suggest similarly large

CES Total Nonfarm Employment by Region, Trough to Peak (Q2 2003 to Q4 2007), Seasonally Adjusted, in thousands

CES Total Nonfarm Employment by Region, Peak to Present (Q4 2007 to Q4 2008), Seasonally Adjusted, in thousands

CES Total Nonfarm Employment by Region, Q1 2001 to Q4 2008, Seasonally Adjusted, in thousands

CES Heartland Region Supersector Employment Peak to Trough (Q1 2001 to Q2 2003), Seasonally Adjusted, in thousands

CES Heartland Region Supersector Employment Trough to Peak (Q2 2003 to Q4 2007), Seasonally Adjusted, in thousands

CES Heartland Region Supersector Employment Peak to Present (Q4 2007 to Q4 2008), Seasonally Adjusted, in thousands

CES Heartland Region Supersector Employment Q1 2001 to Q4 2008, Seasonally Adjusted, in thousands

Changes in Nonfarm Industry Employment in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

LAUS Changes in Employment Dec 2007 to Jan 2009, Seasonally Adjusted

LAUS Changes in Unemployment Dec 2007 to Jan 2009, Seasonally Adjusted

LAUS Changes in the Unemployment Rate Dec 2007 to Jan 2009, Seasonally Adjusted

Changes in Occupation Employment in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

Changes in Employment by Gender in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

Changes in Unemployment by Gender in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

Changes in Labor Force by Gender in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

Changes in Employment by Age in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

Changes in Unemployment by Age in the Heartland Region, Civilian Workers Age 16+, Dec 2006-Jan 2007 Avg to Dec 2007-Jan 2008 Avg (Not Seasonally Adjusted)

Changes in Unemployment by Age in the Heartland Region, Civilian Workers Age 16+, Dec 2007-Jan 2008 Avg to Dec 2008-Jan 2009 Avg (Not Seasonally Adjusted)

Understanding the Labor Market in a Deflationary Economic Context