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Economics Weekly - High unemployment - a symptom of the debt crisis; Weekly economic data preview - US payrolls to post first gain in four months

Economics Weekly 4 October 2010


High unemployment - a symptom of the debt crisis



Unemployment remains high in all of the advanced economies and in some is still rising. Almost a year into the economic recovery, unemployment in the eurozone rose to 10.1% in July 2010. It seems that recovery from the recent recession has not had the expected impact on unemployment levels. Still, it is well known that unemployment lags the economic cycle. So are the trends we are seeing in unemployment that different from previous recessions? We explore that issue in this Weekly.


Even a brief glance at the extent of the output gap – the extent to which current output ncompares with the long run potential – suggests that there is still substantial spare capacity in the economies of the advanced countries. History suggests that in this environment, unemployment continues to rise. It is not until actual output rises above potential, that there is a sustained fall in the unemployment rate.


Admittedly, employment usually starts to increase before unemployment falls, but not to the extent that it results in a fall in the rate of unemployment. What is the reason for this? The short answer is growth in the labour force. If growth in the labour force - which includes the number of people looking for work - is faster than growth in employment, then the unemployment rate will increase. For instance, when the economy is in recession or slowing sharply, the rate of unemployment rises and people find it hard to get work. A proportion of them tend to leave the labour force, and stop searching for jobs. This then reduces the unemployment rate. In an upswing, however, these ‘discouraged workers’, tend to rejoin the labour force, and, depending on the numbers, this will mean only a slow fall in the unemployment rate. But this does not seem to be what is happening at this time. Rather, with a still large output gap, there simply is not enough economic growth at present to increase job creation sufficiently to lower unemployment rates significantly. Indeed, in the Euro area unemployment is still rising. In the US, unemployment is at least beginning to fall. In the UK - where the rate of unemployment did not rise as much as in the US or the Eurozone - it is still high, despite UK economic recovery starting in Q4 2009, see chart b.


We would have to go all the way back to the 1930s to find a period when US economic growth has fallen as much as in this recession. Comparing the two worst recessionary periods since the 1970s suggests that the rise in US unemployment could have been worse based on the drop in gdp. As US economic growth has recovered back into positive territory, the unemployment rate is already beginning to fall. If economic growth continues to recover, it seems likely that US unemployment will fall further. However, the US economic recovery - like that in other advanced economies has been badly affected by the credit crisis and is being held back by the need for companies and households to reduce their debt burden. Hence, the fall in unemployment is likely to be rather slower than in recessions where there has been no financial shock. (See our Weekly dated 16th August 2010).


In the case of the UK, unemployment is not falling, even though the annual rate of GDP growth has turned positive. An even worse profile is evident in the Eurozone where even though the economy has recovered, unemployment is still rising. It is not hard to find reasons for why that is occurring. Obvious contenders are deficit economies suffering debt crises, like Greece, Ireland, Portugal and Spain, which have seen unemployment jump well into double digits in the past year. Worse, there are signs that the crisis in these economies could persist for some time and could even deepen.


Is this economic crisis really having a worse impact on unemployment rates than previous downturns? One way of answering this is to compare the evolution of unemployment in previous recessions to the latest one. This is shown in charts c and d for the UK and US. This analysis shows that US unemployment is not quite as high as it was in the 1980s downturn, but it is much worse than in the 1980s or the 1970s recessions. It could be that the US unemployment rate does fall as quickly as in the 1980s downturn and to similar lows in the same sort of time frame. However, as the chart shows, it is too soon to make this judgement.


Given the lags that unemployment has with the real economy, we will not be able to say that unemployment has performed better or worse in the case of the US for about another 3 years. It took the US economy over 24 quarters, or 6 years,  before unemployment fell to the level that prevailed before the onset of recession. In short, there is another 3 ½ years to go before any assessment of the unemployment performance of the US economy in this recession could be said to be worse than in any recession since the 1970s. For the UK, the evidence already shows that unemployment has peaked at a lower level than in the 1980s and the 1990s recessions, see chart d. It is worse than the 1970s, but then it continued to rise for much longer. In short, the evidence for the UK suggests that unemployment has performed better than could have been expected, especially given the debt crisis. It may be too soon to be sure, but so far cuts in take home pay seem to have alleviated the effects of the recession on UK unemployment.


Overall, this evidence has to be seen as good news for the US and UK. Despite the worst economic and financial crisis since the 1930s, the behaviour of labour markets in the US and the UK has not been anything as bad as then. This is evidence that having flexible labour markets can and does mitigate the effects of economic crisis on unemployment. Whether this is true for the eurozone remains to be seen.


Trevor Williams, Chief Economist,

Corporate Markets



Weekly economic data preview 4 October 2010


US payrolls to post first gain in four months


This week sees a number of key UK data releases with the Bank of England interest rate announcement, the publication of the services PMI index and industrial output figures for August. The policy decision itself is expected to be straightforward, with both Bank Rate and the size of the QE program left unchanged. However, the debate surrounding the appropriate level of policy is certainly heating up. Data over the past month have painted a more downbeat picture of the UK economy, with the prospects for the services sector being of particular concern given the falls in the monthly index in both June and July. Of course, in the Inflation Report back in August, the Bank had forecast growth to slow in coming quarters, so the question really is whether it has done so by more than the Committee had been expecting. It is almost certain that Andrew Sentance will argue that the answer is ‘no’ and that the volatility in the monthly data is entirely consistent with the normal fluctuations in the growth cycle. As such he is likely to vote for a rate hike for a fifth month in a row. But on the opposing side of the debate, Andrew Posen made it clear in a recent speech that he thinks the recovery is flagging and requires further support. We suspect that it will take some time for the remaining members to make up their mind, but our own view is more closely aligned with Posen’s interpretation of recent events and we look for this week’s data to strengthen his side of the argument. In particular, we expect the closely-watched services PMI to show that growth in the sector is close to stalling, with the employment component being particularly weak. Official manufacturing output figures for August, on the other hand, are forecast to show a small rise, although the outlook has been clouded by a further drop in the manufacturing PMI.


We forecast US non-farm payrolls increased by 20,000 in September, marking the first gain in four months. The retiring of temporary workers related to census 2010 will again have a major bearing on the outcome, although the headcount was down to just 82,000 in August from a peak of 564,000 in May. We look for overall government employment to fall by 55,000, while private sector payrolls are forecast to increase by 75,000, up from 67,000 last month. The September employment report will include the latest benchmark revisions to reflect new seasonal adjustments and birth/death adjustments, leading to potentially significant changes to past data. The Household Survey data are expected to show a slight rise in the unemployment rate to 9.7%, reflecting a modest rise in labour force participation. The average workweek is predicted to remain steady at 34.2 for the third successive month, while hourly earnings post a 0.2% gain. A key function of data ahead of Friday’s employment report will be to help refine estimates and highlight potential risks for this release. The non-manufacturing ISM will therefore be watched on Tuesday as closely for the headline number as for the employment sub index. We look for modest improvement in both. The ADP employment report, on Wednesday, is forecast to show a 25,000 gain in private sector jobs. Fed speakers this week include Bernanke and Hoenig.


The highlight in the eurozone this week is the ECB interest rate meeting on Thursday. We expect no change to policy but the press conference should provide several points of interest and debate. Meanwhile, in Australia, the interest rate debate has heated up once again. While there are arguments both for and against a rate rise, we believe the former will prevail and look for the RBA to raise rates by 25 basis points at its meeting on Tuesday on the back of the strong labour market conditions. In contrast, the Bank of Japan looks set to debate additional stimulus measures at its monetary policy meeting on Monday.


Economic Research team


Lloyds TSB Corporate Markets Economic Research, 10 Gresham Street, London, EC2V 7AE, Switchboard: 0207 626 1500. Bloomberg: LLOY<GO>



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