Monetary Morphine and the Job Market

  Monetary Morphine and the Job Market                                        

   Pablo Paniagua             

Ben Bernanke, the Fed Chairman, stated this week that the Fed would leave the door open for further monetary easing for the years to come, in an effort to support the job market and try to contain the unemployment rate. It is also an extended endeavor to maintain the “full employment” objective established in the Fed’s baffling dual mandate, along with the “prize stability” objective. The relevant question at this point would be if further monetary easing will help the job market in the long run or not.

A key issue in understanding this problem is to recognize why the US has a high unemployment rate in the first place. The recession might be the common answer. Indeed, the recession has pushed companies all around the world to moderate their employment base and cut costs, leading to a short-term shock in global job markets. This distress led to a sharp increase in the unemployment rate ever since 2007. However shocks are not always transitory; nor easy to revert, especially given that the present one came from the biggest “leverage” recession since the Great Depression. The negative upset in the job market could be seen as a dual effect that needs to be analyzed with more accuracy.

The first job market effect of a negative economic recession shock is mostly cyclical and is a common element in all sorts of negative distresses and mild recessions (especially those linked with massive debt restructuring and deleveraging, both from companies and from consumers). This usually leads to a huge contraction in investments and consumption. The process unfortunately leads to a cyclical unemployment effect in the short run, naturally leading the economy to deal with this contraction and deleveraging. In these kinds of cases however, the economy experiences mild slumps or consumer led contractions.

Monetary policy interventions can somewhat aid the macroeconomic situation by stimulating the economy in the short term and creating a positive virtuous circle for consumption and investment, which might lead to lowering the unemployment rate. Note that this is only true and effective when the economy has experienced a mild recession or contraction, not when the economy has experienced a catastrophic credit crisis and an incredible misallocation of factors of production in some sectors of the economy (such as housing or construction).

Bernanke’s speech this week makes us think that he believes we are in the former kind of mild recession, rather than the latter; and more monetary easing can help the job market. Giving the impression that he thinks this is a cyclical problem rather than a huge structural misallocation of the American working class in some sectors of the economy. These improperly allocated investments and factors of production were due to a huge monetary increase led by the former Fed chairman Mr. Allan Greenspan for more than 15 years.

It would not be difficult to grasp the irony in the job market puzzle. But the Fed thinks they can help the unemployed through more monetary stimulus and further government intervention. In reality, the last couple of decades have undisputedly shown that this sort of massive economic intervention causes huge malinvestment and a dreadful job allocation in “bubble” sectors of the economy. The fed believes further intervention is the solution, when in fact it has been the problem in the first place.

All the bad signals given by policy interventions to the investors and to workers, will eventually transform to nothing more than in another economic crisis and more structural unemployment, which will not respond to any further Monetary Morphine.    

The second effect in the job market is strictly structural and it is more difficult to deal with and to pinpoint by monetary policy than the previous one. Structural problems in the job market reflect far deeper problems. Economists identify some of these problems as: the existing mismatching between the skills that workers have or developed and the ones that the market requires at a given time. In other cases some workers stay so long out of work that they become effectively unemployable, implicating that their skills erode over their time while being unemployed. Economists call this process of permanently unemployment “hysteresis”, which is a term to reflect the long-term unemployment experienced in Europe in the early 80’s. Evidently the last crisis suggests that the US might be experiencing a similar problem, which was catalyzed by the massive intervention of the money supply that gave investors and workers the wrong signals as to where to direct their economic decisions. This drew them in mass to specific sectors of the economy, consequently leaving them consequently, trapped with the skills they had developed, once the bubbles in those sectors inevitably burst. It is relevant to address the fact of how discretionary policies lead large parts of the population to make the wrong decisions in regards to their careers or investments, which are only unfortunately revealed once the misallocations are corrected by market forces. This leaves the current unemployed workers trapped with skills that were sustained and demanded only through monetary folly.   

     

Undeniably this huge monetary expansion and the possibility of even further intervention is not going to improve the job market any further because, as we have seen the problem was monetary intervention in the first place. This time it is unlikely that monetary intervention will be the solution, especially since the problem is rooted in the distorted structure of the economy.  Even this large expansion of the quantity of money (as shown in the Chart I) will bring more risks rather than improvements. Once the massive quantity of fiat money is finally poured into the real economy, it will create further distortions in the structure of production and more malinvestment in the previous “bubble” sectors of the economy as well as higher inflation in the long run. 

As we have experienced in the last 3 decades, lower interest rates and bloated fiat money is the basic fundamental environment for asset bubbles and “boom and bust” cycles. John Taylor wrote this week in the Wall Street Journal, “By replacing large decentralized markets with centralize control by a few government officials, the Fed is distorting incentives and interfering in the price discovery with unintended consequences throughout the economy.” Mr. Taylor is right, but not only will it interfere in the price discovery but also in any further (if at all possible) possibility of cleaning the malinvestment and purging unsustainable growth. Such a plan, dampens any further prospect of reestablishing a natural balance in the job market.  

In conclusion further money printing could boost some assets prices. This is especially true in the stock market, helping banks to clean their balance sheets and become more willing to lend in the future. The risk here however, is that markets and asset classes will become dependent and hook on more monetary stimulus like patients became dependant on morphine, but the marginal effectiveness of the stimulus is diminishing over time. This will lead the Fed towards a dead end game in money easing. However this stimulus scheme will end, the job market restructuring will be far enough away from the monetary policy reach.

Chart I. Monetary Stimulus by the Fed

 

 

Source: Federal Reserve Board H.4.1.