Scott Sumner  

Unemployment was 9.0% in May 1975, and money was too easy

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There's a lot of discussion about the natural rate of unemployment. Some think we are already close to the natural rate. Others think the labor market is much weaker than the official 6.6% figure would suggest. Evan Soltas has what looks to me like the best analysis of the situation:

The fact that the unemployment rate appears to be a robust predictor of the quit rate both before and after the 2007-2009 recession suggests that the unemployment rate, our imperfect observation of labor-market tightness, is a close proxy for the tightness people think is important when they decide to quit or not to quit.
Evan calls the labor market "tight." I probably wouldn't use that term, but we both agree that 6.6% unemployment is a pretty fair characterization of the actual state of the labor market. The natural rate of unemployment has not changed much in recent decades.

In May 1975 the unemployment rate was 9.0%. And yet strangely enough monetary policy was actually too loose at the time. NGDP grew at a 9.1% rate in the second quarter of 1975, and an astounding 12.1% over the next 4 quarters. The high inflation of the 1970s had nothing to do with supply shocks (RGDP growth was normal) it was simply excessively fast NGDP growth, plain and simple. Easy money.

The Fed should have tried to gradually reduce the NGDP growth rate, over a period over years. Instead the problem got worse after 1975. Indeed even Volcker initially made the problem worse. His sharp swing toward easy money in the run-up to the 1980 election pushed NGDP growth to an annual rate of 19.91% in late 1980 and early 1981. (No, that's not a typo.) Only after Reagan took office did Volcker finally decide to bring inflation down.

The central bank can never really know where the natural rate of unemployment is. If they had a proper monetary policy they would not even pay any attention to unemployment.

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COMMENTS (11 to date)
John Becker writes:

The 1970s (and early 80s) were a good example of the dual mandate gone wrong. What if they were just inflation targeting? Wouldn't this have done the same thing as NGDP targeting during that decade?

Andrew_FL writes:
we both agree that 6.6% unemployment is a pretty fair characterization of the actual state of the labor market

I'm not inclined to agree. The labor force is shrinking. And even if we believe no one younger than 16 or older than 64 should have to work, that segment of the population is not shrinking. And yet the unemployment rate trends down. This doesn't seem like the healthy labor market people want to infer?

Yancey Ward writes:
If they had a proper monetary policy they would not even pay any attention to unemployment.


Edgar writes:


Please give me your best reference to a paper analysing in detail the definition and measurement of the natural rate of unemployment.


Only after Reagan took office did Volcker finally decide to bring inflation down.
And he praises Reagan in him memoir for supporting him in that decision.
rvman writes:

Andrew: Yes, the labor force is shrinking - that is at least partly demographic. The population which turns 65 in a given year just exploded from about 2.5MM in the 2008-2010 timeframe to about 3.2MM per year in the 2013-2015 time frame. There are more people in the age 50-60 brackets (where people start dropping out of the workforce) at the trailing end of the baby boom than in the 35-45 bracket(which sees lifetime peak employment rates) of baby-"busters"/GenX.

Meanwhile at the younger cohorts, the 1990-1993 cohort is bigger than earlier age groups, so low-age employement is dominated by those just out of school and in some cases not yet fully employed. We had the bad luck that an abnormally large cohort started hitting the job market JUST as the 2008 recession hit.

See the graph, here, for 2010. Look at the discontinuous jump around age 62-63 (which is 66-67 now) the trough around 30-40 (now 34-44) and the lump at 16-21 (now 20-25).

Scott Sumner writes:

John, The 1970s were not the dual mandate gone wrong, they completely ignored this mandate in the 1970s. But yes, inflation targeting might have been better than what they actually did. However in that case the inflation target should have been fairly high, say 4%, as there were some extreme energy price shocks.

Andrew, That's a different question. Yes, there are people on disability and early retirement who might normally be working. Our point is that more AD won't get them jobs. They are gone for good.

Edgar, Milton Friedman defined the concept as well as anyone (in 1968). Maybe someone else can recommend an empirical paper.

Andrew_FL writes:

@rvman-Year over year growth rate of working age population, that is, aged 15-64, was 0.4% in December. I don't think January is out yet but that number has not been negative at any point. The growth rate of the civilian labor force in the same month, relative to the previous, was -0.4%. The most recent value is -0.2%. So as I said, even if we assume, in spite of people living longer, that the retirement age should remain fixed at 65 in perpetuity, the labor force is shrinking, and demographics don't explain that. They'd explain slow growth, they'd explain some of a flat employment/population ratio. They don't explain the actual number of people in the labor force going down.

And to add some clarity on that point, the rate of growth of the labor force growth was mostly negative after the "end of the recession"-and positive during it-from 2009 to late 2011. During 2012 it was positive again...and then the rate dropped back down to negative.

@Scott Sumner-Gone for good if we fixate on AD as the only element of economic policy, or gone for good as in, there is literally no conceivable policy that will make the labor force grow again?

Lorenzo from Oz writes:

I have never quite got my head around the Market Monetarist story for the 1970s. That NGDP growth was too high is fine--see inflation rate. It is the unemployment side of the story that does not quite come together for me.

W. Peden writes:

Lorenzo from Oz,

High unemployment in the 1970s (and 1980s) was due to a rise in the natural rate of unemployment. It would have occured regardless of whether or not monetary policy was better, and needed better microeconomic policies in order to be addressed.

Of course, some of the fluctuations within the unemployment rate in the 1970s and 1980s were due to NGDP growth changes.

Kevin Erdmann writes:

I address Evan's post here:

Short version: The quits rate and the unemployment rate are both understating the strength of the labor economy.

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