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You Decide!, by Dr. Mike Walden

You Decide!

By DR. MIKE WALDEN William Neal Reynolds Distinguished Professor Emeritus N.C. State University

You Decide: Will We Have the First Full Employment Recession? Debates are still raging over whether the economy is in a recession. While the economy has met one litmus test for a recession of two consecutive quarters of negative growth in GDP, or gross domestic product, doubters point to the still strong job market. In recent months, hundreds of thousands of jobs have been created, and unemployment remains very low.

This situation has raised an interesting question. Could a recession happen, but the labor market doesn’t participate? That is, for the first time in my memory, could we have a recession without big job losses and jumps in unemployment?

It’s an interesting question that has already created differing opinions among leading economists. Some top economists think a recession today will be just like those in the past, where many jobs were lost, and the unemployment rate soared. Excluding the 2020 recession induced by the pandemic, in the recessions since 1980, unemployment jumped an average of three percent, and the jobless rate rose an average of four percentage points. Today, some economists are predicting the unemployment rate may reach seven percent - double the current rate – in a recession brought on by a goal of reducing the inflation rate to two percent annually.

But, not surprisingly, other economists disagree. Currently, there are almost two job openings for every unemployed person. That is unprecedented, especially during what – some claim – is already a recession. The current level of job openings is almost 11 million, equal to seven percent of filled jobs. This is more than enough to allow businesses to cut unfilled jobs rather than filled jobs and meet the job losses that come with the average recession.

Indeed, this is exactly what some economists think will happen. One respected economist predicts we will see, at most, a one percentage point increase in the jobless rate in the coming months. We could therefore have a reduction in economic production – which is one definition of a recession – while experiencing a very, very modest increase in unemployment.

If this situation happens, would we actually see no recession declared? The National Bureau of Economic Research (NBER), a century old private think tank, makes the official calls on recessions. NBER looks at six measures in deciding if a recession has occurred. They are the change in earned personal income in excess of inflation, the change in personal spending in excess of inflation, the change in nonfarm payrolls, the change in household employment, the change in manufacturing and retail sales in excess of inflation, and the change in industrial production.

Before discussing trends in these measures, let me explain the difference between the two employment measures. The government does two job surveys each month. The payroll survey is based on results from a sample of 400,000 businesses, but not including farms. People on business payrolls are counted as employed.

The household survey relies on a much smaller sample of 60,000 households. However, the household survey is broader, including not only workers on farms but also self employed workers, unpaid family workers, workers in private households, and workers on unpaid leave. The household survey, therefore, captures more types of jobs, but it’s based on a much smaller sample.

The payroll job survey has continued to move higher, but the household survey of jobs peaked in March and has been slightly lower since then. Personal income has continued to rise, but there are signs of leveling off for personal spending. The production index has been gaining, yet manufacturing and trade sales have been dropping.

So, with three (household job survey, personal spending, manufacturing/trade sales) of the six key measures followed by the NBER suggesting some weakness, there is reason to watch the economy for deepening signs of a recession.

But if a recession does occur, will it be a typical recession with all six indicators – and especially the two job indicators – showing significant deterioration? Like so many aspects of our lives impacted by the pandemic, I think a case can be made that the next recession will be different.

Imagine this scenario. Production, sales, spending, and income trend downward in the next six to nine months as the Federal Reserve raises interest rates to control inflation. But with improvements in the supply chain, falling oil and gas prices, and a more modest inflation rate of 4-5 percent, the Fed will declare victory, stop raising rates, and hint about actually lowering rates over the coming year.

With economic optimism returning, businesses that have stopped hiring new workers will now begin worrying about a return of labor shortages as the economy improves. Hence, they keep their labor staff intact, and few – if any – workers are let go. The unemployment rate barely rises, making the recession the first one on record occurring without a major jump in joblessness.

Is this a fantasy? Perhaps. But it wouldn’t be the only unusual event created by the pandemic. The COVID-19 pandemic has changed the workforce, altered how we buy both products and services, and broadened remote working and remote living. Is our definition of a recession the next post-COVID change? Could we experience a recession without massive unemployment? You decide.

You Decide: Should the Fed Stop Influencing Interest Rates? The Federal Reserve (the “Fed”) is now in the process of increasing interest rates. This is a tactic the Fed uses when it wants to slow the pace of the economy in order to reduce price increases. Stated another way, the Fed is increasing interest rates to reduce the inflation rate.

The Fed followed the opposite interest rate policy during the pandemic. Then the objective was to increase spending and economic growth in order to combat issues from the COVID-19 pandemic. The Fed lowered its key interest rate – the federal funds rate – to almost zero. The policy worked as the economy strongly rebounded and returned to pre-COVID levels by early 2021.

But many economists think the Fed’s policy of extremely low interest rates during the pandemic has led to the high inflation rates we are now experiencing. Extraordinarily low interest rates and the money the Fed effectively created to support those low rates sparked a buying spree by consumers that exceeded the availability of products constrained by supply chain problems.

Hence, the Fed’s policy of low interest rates to deal with one problem – recession – led to another problem – inflation – and caused the Fed to switch to the exact opposite policy of higher interest rates. Does this seem somewhat counterproductive?

It’s not just recent Fed policy that would cause many to answer “yes” to the question. It’s that we can see the same Fed policy used in previous years. For example, interest rates were very low prior to the subprime recession of 2007-2009. The Fed raised its key interest rate to contain the jump in prices – particularly home prices – which then brought on the recession. To end the recession, the Fed lowered its key rate to almost zero, where it remained for several years. It’s a pattern we’ve seen several times since World War II.

Why does the Fed follow this up and down interest rate policy? The answer goes back to the 1930s when the country experienced the Great Depression. The Fed was a young institution then, and it was roundly criticized for not using its powers to fight the Depression. Worried that the country would face another depression after World War II, Congress told the Fed to use its powers to keep unemployment low and prices stable.

Hence, the real debate is whether the government – particularly the Federal Reserve – should act to smooth out the ups and downs in the economy. That is, should the Fed take action to “cool” the economy when it is running hot, and inflation is surging? Also, should the government move to stimulate the economy when it is down, joblessness is rising, and businesses are failing?

This is an old debate that also began in the 1930s. The argument for stimulating the economy when it’s down is easy to make because people and businesses suffer when economic times are bad. There is pressure for the government to spend money to reduce the suffering of households and to keep as many businesses alive as possible. There is also support for the government to create conditions that will allow the private economy to come back. This is where the Federal Reserve’s policies of low interest rates and ample money creation come in.

But there are several arguments against an active role of government – and particularly the Fed – to influence the macroeconomy. The major complaint is that – rather than smoothing the ups and downs in the economy – the Fed’s actions could actually contribute to those ups and downs.

Critics say to look no further than today for an example. The COVID-19 pandemic generated a deep recession in early 2020. The federal government pumped massive amounts of money – some estimates say over $5 trillion – to support households, businesses, and public institutions. The Federal Reserve was a key player in this effort by using its power to create money and fund a large

part of the $5 trillion by pushing its key interest rate to zero percent.

Now many analysts say we are “paying for” these actions with higher inflation rates, a result of “too much money chasing too few goods and services.” As a result, the Fed has reversed its policies and is raising interest rates, reducing the money supply and creating the conditions for a possible recession.

There are other criticisms of the Fed’s active policies in guiding the economy. One is that its policies of lowering interest rates and creating money most help wealthier households who have financial investments – such as stocks and bonds – that greatly benefit from the policies. Also, when the Fed raises interest rates that could prompt a recession, job losses are concentrated among lower-income workers, with many higher-income jobs protected. Both of these impacts of Fed policies could contribute to greater income inequality.

Recognize that this debate over Fed actions sets up a very difficult choice. Should we let the economy run its course? That is, when the economy weakens – for whatever reason – and unemployment rises, incomes decline, and bankruptcies surge, should the Fed follow a “hands off” policy and let the economy heal itself? Also, should the Fed be passive when high inflation is an issue?

Or, should the Fed take an active role in managing the economy, even if the Fed’s actions actually make the economy more unstable and unequal in income?

These questions have been around for almost a century, and they won’t be resolved overnight. Still, we should periodically revisit them, have a debate, and then decide!

You Decide: Is The Social Safety Net A Spring Board Or A Cushion? There are few public issues that create more debate than the “social safety net.” By social safety net, I mean the set of government policies, programs, and regulations that provide money, services, and products to households that cannot maintain an acceptable standard of living using their own resources.

There are many pieces to the social safety net. At the federal level, food assistance through the Supplemental Nutrition Assistance Program, medical assistance via Medicaid, and a program that provides cash to households — the Earned Income Tax Credit — are key examples. It’s estimated these, and complementary programs give assistance worth almost $800 billion annually to eligible households. During the COVID-19 pandemic, spending was much higher.

States are secondary to the federal government in funding the social safety net. States do administer their own unemployment compensation systems and set their minimum wage level.

The social safety net has come under scrutiny in recent years. This is due to the extra federal help to households during the COVID-19 pandemic. The additional assistance came in many forms: supplemental jobless benefits, stimulus checks, expanded food and medical aid, and payments to households with children. Most of this extra funding has stopped, with extra food and medical care being the exceptions.

During the pandemic, a fresh debate over the social safety net emerged. Some thought the generous help made the safety net too broad and claimed it discouraged people from taking jobs when they became available. There are some analysts who think the after effects of the enhanced social safety net continue and are partially responsible for today’s labor shortage.

There’s also a related debate in North Carolina. While North Carolina has received praise for its business climate and is among the state leaders in attracting new firms, some argue this success has come at the expense of the social safety net. Specifically, critics say workers are hurt by the state’s low minimum wage rate, modest jobless benefits, and limited regulations for businesses’ interactions with employees.

The social safety net has always been a hot button topic because competing sides see different approaches to reaching the same goal. The goal is a thriving economy with ample options for workers to have a reasonable income that will enable them to achieve a decent standard of living.

One approach sees this goal best achieved by attracting firms paying good salaries because they like the business climate in the state and they see opportunities for hiring needed workers. Firms like to be in control, and they like to set their salaries and wages without interference from the government. In this approach, it is key for workers to see a distinct financial advantage to work compared to receiving government help.

While the alternative approach certainly welcomes good paying businesses to the state, supporters worry about what happens to workers in the interim before they are trained and prior to the good jobs coming. Hence, this approach supports a more robust social safety net that will provide constant protection to workers.

The debate over the social safety net and the best approach to business recruitment is particularly important for North Carolina. Few states have witnessed the kind of economic transformation North Carolina has faced in the last half century. Industries that dominated the state economy and provided thousands of middle paying manufacturing jobs — tobacco, textiles, and furniture — have been devastated by international trade. Good paying jobs that replaced them have largely required college degrees. This has left tens of thousands of workers in the state without college training, settling for low wage employment.

North Carolina has tried to rebuild its manufacturing base by attracting new firms to the state. Here, the state has largely followed the first approach of luring jobs by presenting a “business friendly” environment.

At the national level — where most of the social safety net is woven — there are two big questions. The first is: how strong should the safety net be? Should it be strong enough to allow the household to be economically comfortable? Or, should it only provide enough resources for people to “just get by,” therefore giving them a big motivation to improve their skills so they can move on to a better living standard?

The second question is how to adjust financial help from the social safety net when a recipient does earn more on their own. Should there be a dollar reduction in government help for every dollar gain in earnings? But if this tradeoff is made, then what incentive does a person have to do better on their own?

Unfortunately, research over several decades shows that, on average, a dollar — or even more than a dollar — of government benefits is often withdrawn for every additional dollar a recipient earns. This is particularly the case for households moving from the lowest paying jobs to middle paying jobs. A major reason for this result is that individual government programs often aren’t coordinated. The “big picture” impacts are often ignored.

I think we can all agree this last problem should be fixed. We want people receiving benefits from the social safety net to be better off if they can earn more on their own.

I see the debate about the generosity of the social safety net continuing, particularly here in North Carolina. While we may all agree we want more households to prosper, each of us will have to decide the best way of achieving this result.

December 3, 2022 • 12:00 noon

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