Arnold Kling  

Lectures on Macroeconomics, No. 5

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So far, I have focused on unemployment as a problem of adjustment. In this essay, I review the history of the Dotcom recession, and I focus on the index of aggregate hours worked as an indicator of macroeconomic performance. According to this indicator, the Dotcom recession was quite severe. This in turn raises interesting questions about other indicators and about the policy history.

Below is a table showing the index of hours worked in the nonfarm business sector for the three deepest post-war recessions, starting with the pre-recession peak and moving forward eight quarters (two years) at a time.


Oil RecessionVolcker RecessionDotcom Recession
Pre-recession Peak1973 Q41979 Q42000 Q2
Hours Index at Peak77.987.2121.9
2 years Past Peak75.086.3116.3
4 Years Past Peak80.988.6116.5
6 Years Past Peak87.294.6121.1

Using this measure, the Dotcom recession seems to have been much worse than the previous two, particularly in terms of length. It was not until the fourth quarter of 2006, 6-1/2 years after the peak, that the hours index edged above its peak level. It stayed above the earlier peak for four quarters, and has since slipped back below.

The reason that most people do not look at the Dotcom recession as being a severe one is that the flagship indicators, GDP growth and the unemployment rate, were better behaved during the Dotcom recession. GDP growth was reasonably robust, because productivity growth was high. The unemployment rate remained low, because labor force participation fell.

Overall, my sense is that the Dotcom recession saw a change in the composition of the labor force that favored higher productivity. For example, from the second quarter of 2000 to the second quarter of 2006, the number of employed persons aged 25 and older with a high school degree went from 36.7 million to 36.9 million, essentially no change. Over that same period, the number of employed persons aged 25 and older with a college degree went from 36.0 million to 41.3 million, an increase of more than 14 percent.

Interestingly, the labor force participation rate of college graduates declined by more than that of those with just a high school degree. The participation rate of the latter declined from 64.4 percent to 63.4 percent, while the participation rate of the college graduates fell from 79.8 percent to 77.6 percent.

My interpretation:

1. The work force became weighted more toward the college educated. Presumably, those who aged out of the labor force and retired were disproportionately less educated than those who joined the labor force.

2. A relatively high proportion of the college-educated dropped out of or failed to enter the labor force, as indicated by the decline in their labor force participation rate. This decline presumably reflected a more difficult job market during the Dotcom recession.

3. Nonetheless, the composition of employed persons shifted markedly toward more employment of those with a college education. This may account for some of the strong productivity gains. However, I should point out that the more educated labor force tends to have occupations where hours and output are both harder to measure than the classic factory job. Both the numerator and the denominator of output per hour are less reliable.

4. Perhaps what makes the Dotcom recession unusual is the behavior near the peak. It could be that there was an unsustainably high level of employment as a result of Internet companies taking on large numbers of workers in spite of having little or no revenues. In a more realistic job market, more people choose to remain out of the labor force.

5. The severity of the Dotcom recession as measured by the hours index makes it difficult to criticize the monetary policy of 2001-2004 from a conventional Keynesian perspective. If you were to use hours worked rather than the unemployment rate as an indicator of labor market conditions, then you certainly would argue for a policy of monetary easing.

However, in terms of these lectures, to discuss monetary policy is to get ahead of our story somewhat. So far, I have hinted that when there are severe structural imbalances that require wage cuts, expansionary monetary policy might serve to produce the required adjustments by raising prices relative to wages. However, it seems far-fetched to suggest that what we needed from 2000-2006 was inflation in order to cut the real salaries of college graduates so that employers would retain them. The period of 2000-2006 would seem to me to be long enough for a lot of labor market adjustments to work out on their own. If college graduates were not participating in the labor force in 2006 to the extent that they did in 2000, I am reluctant to attribute this shift to inadequate macroeconomic stimulus.

In fact, I am extremely cautious about any conventional macro stimulus theory, given the complexity of labor market dynamics these days. But, again, that is getting ahead of the story.

Previous entries in this series:
1. Introduction
2. Misconceptions about Labor Markets
3. Unemployment as an Adjustment Problem
4. Why Wage Cuts are Rarely


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COMMENTS (4 to date)
Jacob Oost writes:

Keep 'em coming!

For how long do you see neo-Keynesian macro being dominant? I'm worried it could be for a very long time. Politicians always want to be seen as "taking action" in tough times, which automatically creates a market for economists who will give politicians placebo (or worse) policy suggestions.

English Professor writes:

For us non-economists, can you tell us something about what is measured in this index? What does it mean to have a value of 77.9 in 1973 and one of 121.9 in 2000?

Caliban Darklock writes:

English Professor:

An index of hours worked is the estimated number of hours worked by an average employee (here, in non-farming occupations) over an arbitrary timespan - usually one week, one month, one quarter, or one year. It is normal to consider the peak index for a short timespan within a longer timespan.

Ultimately, the actual number (or the timespan) means comparatively little. What matters is the relative change between numbers, and the recovery of the index over time. Both the Oil and Volcker recessions rebounded above the original index by four years after the peak and continued rising. the Dotcom recession, however, had still not fully recovered after six years. Furthermore, the two-year changes are -3.7, -1.0, and -4.5 percent respectively... so in the near term, the Dotcom recession also had a harsher impact.

Non-economist here, too, so someone with a real economics background should feel free to correct me if I've completely hosed this up.

MattYoung writes:

Still working in how we managed to get all those job classifications, and what they mean to the individual.

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