Jobs Report: STIM II, no STIM or Tax Cuts?

By Neeta P. Fogg and Paul E. Harrington

The monthly jobs report released today provided little comfort to those hoping for a strong turnaround in the job market over the next few months. Private-sector payroll employment levels in the nation increased by just 67,000 jobs between July and August. However, most of the gains in private sector employment came from health services (+28,000) and social assistance agencies (+12,000), both heavily funded by government sources. Offsetting these private-sector gains were the layoffs of another 110,000 temporary Census workers, as the 2010 Census winds-down. The net result is that the overall payroll employment ended up declining by 54,000 jobs over the month.

The nation’s unemployment rate for August was 9.6%, essentially unchanged from the prior month’s rate of 9.5%. Over the past few weeks, the argument has emerged that much of the now 9.6% unemployment rate problem in the U.S. is “structural” in character (due to skill mismatches between jobs and job-seekers). National Public Radio reported that economists at the International Monetary Fund (IMF) think that most of the unemployment below 6.75% is structural in nature.

This means that pump-priming policies like a second round of stimulus or an expansion of the Federal Reserve’s monetary easing strategies may not reduce the unemployment rate back to the 4.5% level of 2006-07, because structural barriers such as geographic and occupational skill mismatches have worsened. Such structural barriers mean that even as Gross Domestic Product expands, jobs don’t get filled because workers lack the skills to fill them or because workers are unwilling to move to take available jobs for which they may be qualified primarily because so many mortgages are under water and the overall weakness in the housing market. This view was recently echoed in an unsigned article in The Economist that essentially argued that because so much of the current unemployment is structural in nature, there is not much the government can do about it.

Structural unemployment problems do not respond very much to policies like monetary easing (making money very cheap for banks) or fiscal policies like a second round of stimulus. Essentially, the IMF is arguing that the “full employment unemployment rate” is 6.75% in the U.S. and that, efforts by the government to reduce the unemployment rate below this will fail and produce inflation.

So what does the evidence suggest about a worsening skills mismatch in the American economy? Has the full employment unemployment rate increased to 6.75%? To answer this question we must begin by understanding three basic causes of unemployment and understanding the meaning of a full employment unemployment rate. Unemployment rates at the national and state levels never get to zero percent because of the job-seeking behavior of individuals and the worker-seeking behavior of firms. Job-search unemployment is associated with workers searching for the best jobs for themselves, and employers trying to find the best workers, meaning there will always be some level of what economists call ‘frictional unemployment.” Both companies and workers will take some time to find the right match, and this means some jobs go unfilled for a while and some workers remain unemployed until both sides find the right match.

A second source of unemployment is structural and is associated with education, skill and geographic mismatches between jobs and job-seekers. Technological change and foreign competition make some occupational skills and abilities obsolete while increasing the demand for others. The general tendency in the U.S. is for these changes to result in increased demand for better educated, more highly skilled workers, with a much diminished demand for high school dropouts and lower skilled workers. So one definition of a full employment unemployment rate would be that unemployment rate where all unemployment is either frictional or structural.

The third major type of unemployment (cyclical unemployment) is associated with a decline in the aggregate demand for goods and services that occurs in a downturn in the business cycle such as the Great Recession of 2008-09. The decline in aggregate demand leads to a decline in the demand for workers. Cyclical unemployment is characterized by lots of unemployed workers chasing only a few job vacancies, as contracting businesses eliminate positions and lay off workers, causing unemployment to rise sharply and the number of vacant jobs to fall sharply.

Economists think about full employment in two distinct ways: the Beveridge definition of full employment that is based on the relationship between unemployment and job vacancies and the non accelerating rate of inflation rate of unemployment (NAIRU) that focuses on the relationship between the unemployment rate and the inflation rate.

The Beveridge approach defines full employment as that condition where there is approximate equality between the number of unemployed workers and the number of unfilled jobs. The U.S. is very far away from a full-employment condition under the Beveridge concept. During June, there were 14.6 million unemployed persons in the nation’s labor force and 2.9 million unfilled jobs, a ratio of 5 unemployed workers for every vacant job. This implies that 80% of the unemployment problem in the nation is associated with insufficient aggregate demand for labor, and that just 20% is frictional or structural. With a labor force of 153.7 million, the Beveridge measure of full employment unemployment rate would be about a 1.9%—a long way from IMF’s 6.75% full employment unemployment rate.

The NAIRU full employment unemployment rate is a bit trickier to assess. It is defined as that rate of unemployment at which efforts to further increase aggregate demand will result in an acceleration in the nation’s inflation rate. Monetary authorities have adopted a goal of a U.S. inflation rate of around 2% per year. During most of the past 15 years or so, the full employment unemployment rate under this definition was generally thought to be around 4.5%, although this definition has varied over time reaching 6.5% during the stagflation era of the 1970s.

So what are the risks of inflation?

Not much right now. Indeed, the major threat to most Americans is deflation, as they see their housing values decline, the values of their stock portfolios shrink and a worrisome downward pressure on their wages as the labor market continues to perform poorly. Indeed, the second quarter 2010 GDP growth rate was revised from a low 2.4% annual pace of economic growth to an anemic 1.6%. Such a sluggish pace of growth certainly diminishes any serious concerns about inflation in the foreseeable future. Rather, this sluggish rate of growth has begun to raise questions about a “double-dip” recession, with Goldman Sachs raising the odds of a double-dip recession to one in four.

A debate is now emerging about how to respond to the economic and job market situation. One camp led by Paul Krugman and many of the leading democratic members of Congress argues that we should double down on a new stimulus program, and that the problem with the last one was that it wasn’t big enough.

A second group (perhaps including the IMF) is composed of inflation hawks who argue that we already have massive deficits and a huge monetary base that together pose a real threat of inflation down the road. A third group agrees with Krugman that the threat of deflation is by far the most serious, but that last year’s STIM program was a failure and would be a disaster to engage in STIM Part Deux. They support tax-reduction strategies aimed at reducing the cost of hiring workers and putting more income into the hands of workers by declaring a payroll tax holiday for a year or so.

How the debate about structural unemployment and the full employment unemployment rate gets framed will have a powerful influence in determining the path of economic policy and the nature of economic and labor market activity in the coming months.


Neeta P. Fogg is senior economist at the Center for Labor Market Studies at Northeastern University. Paul E. Harrington is associate director of the center.


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