Highly regarded Northwestern University economist and doomsayer Robert Gordon warns in a new paper that the “U.S. economy may have become more like Europe,” with permanently higher unemployment that cannot be addressed with stimulus from the Federal Reserve.
Gordon, who made waves in 2012 for suggesting that the U.S. might be facing a long-term economic slowdown, argues in new study published by the National Bureau of Economic Research that it might not be possible for the Fed to lower the unemployment rate much further without raising inflation, thanks to a “structural shift in U. S. labor markets.”
Gordon estimates that the natural rate of unemployment has risen from 4.8 percent in 2006 to 6.5 percent today. That means that if unemployment falls below 6.5 percent, inflation will eventually start rising. Unemployment stands at 7.4 percent, having risen from under 5 percent before the recession began to 10 percent at its highest in 2010.
“This result is important news for the Fed,” Gordon writes, warning that “there may be less slack in the U. S. labor market than is generally assumed, and it may be unrealistic to maintain the widespread assumption that the unemployment rate can be pushed down to 5.0 percent without igniting an acceleration of inflation.”
Gordon’s paper is an attempt to reconcile the high post-financial crisis levels of unemployment with the relative lack of deflationary pressures. In many models of the economy that incorporate what is known as the Phillips Curve – a trade-off between unemployment and inflation – today’s widespread unemployment would be associated with steep deflation rather than the steady 1-2 percent inflation that has held over the past few years.
But to Gordon the puzzle of missing deflation “is in fact no puzzle.” He writes that the persistence of inflation through the jobs crisis is consistent with the economic model that he and others developed to explain the “stagflation” of the 1970s. During that time, inflation spiraled out of control even as unemployment soared, a phenomenon that most mainstream economists struggled to explain at the time.
In Gordon’s model, the lack of deflation in recent years can be explained by higher energy prices and declining productivity growth. The high number of long-term unemployed workers is also a significant factor, because the long-term unemployed might be “out of the labor market” in the sense that employers do not consider them eligible hires. As a result, the large numbers of long-term unemployed do not generate the downward pressure on wages that short-term unemployed do, which shows up in inflation data. There were 4.2 million Americans who had been unemployed for more than 27 weeks as of July, out of 11.5 million total jobless, according to the Bureau of Labor Statistics.
If Gordon is right that America’s unemployment problem is increasingly the product of structural forces rather than cyclical ones, his findings could help shape the Fed’s unconventional monetary policies. The central bank has promised to keep interest rates near zero at least until unemployment falls below 6.5 percent – the same rate that Gordon believes is the new natural rate of unemployment.
Fed Chairman Ben Bernanke appeared to be relatively dismissive of the idea that the structural rate of unemployment had risen significantly in a July appearance before the House of Representatives. He told lawmakers then that “so far we don't see much evidence that the structural component of unemployment has increased very much during this period,” and that “it still appears to us that we can obtain an unemployment rate … somewhere in the fives."