Here's Brad DeLong on June 30th 2008, commenting on the Bush administration's decision to enact an emergency unemployment insurance program when the unemployment rate was at 5.5%, roughly the current estimate of the natural rate:
The rule of thumb, IIRC, is that the average duration of an unemployment spell increases by 1/4 of the increase in the duration of unemployment benefits. Thus a 13-week increase in unemployment insurance duration should increase the average unemployment spell by 3 weeks. With current mean unemployment spell duration at 17 weeks, and with roughly 2/3 of the unemployed eligible for UI, this would produce a 3/17 * 2/3 * 5.5% = 0.6% increase in the measured unemployment rate.
It seems to me likely that--whatever happens to the economy--George W. Bush has just produced four bad unemployment-rate headlines on the Saturdays August 2, September 6, and October 4. This cannot be news that John McCain is happy to hear.
DeLong's prediction was exactly correct, the unemployment rate announced on October 3rd was 6.1%.
A few months later Lehman failed and then two days after that the Fed met to decide monetary policy. They voted to keep rates at 2.0%, even though it is obvious now, and indeed was obvious then, that they should have dramatically reduced the fed funds target.
Commenter Kevin Erdmann sent me a portion of the transcript of the meeting.
"Furthermore, we have seen a remarkable decline in inflation compensation for the next five years in the TIPS market. I would not rely heavily on this decline to support my view, but I do have to say that the decline is a lot more reassuring than the alternative. I was also encouraged by the 30 basis point drop in long-term inflation expectations in the most recent Michigan survey. I anticipate that the recent jump in the unemployment rate will place some additional downward pressure on growth in labor compensation, which has been quite low, and in core inflation.
Although the jump in the unemployment rate probably partly reflects the extension of unemployment insurance coverage, a back-of-the-envelope calculation suggests that the upper bound on this effect is just a few tenths of a percent." (pg. 34)
I often have discussions with relative hawkish Austrian economists, who question why I have consistently advocated monetary stimulus over the past 6 years. But even they will usually acknowledge that "of course" monetary policy was too tight in late 2008 when NGDP was falling fast.
There was no "of course" for the dovish Janet Yellen, whose comments are quoted above. (No, that's not Richard Fisher.) Here's how Kevin Erdmann characterized her remarks:
Leaving aside the idea that in September 2008 the FOMC was reassured by a precipitous decline in inflation expectations, note that Yellen here was explicitly saying that the Fed should err on the hawkish side because Emergency Unemployment Insurance was escalating the unemployment rate, and thus masking inflationary wage pressures. The Fed tightening in September 2008 included monetary offset based partly on their belief that EUI inflated the unemployment rate. Keep in mind EUI had only been in effect for less than 3 months, at much less generous terms than its eventual terminus, and the unemployment rate was only 6.1%. I assume that the Fed's hawkish offset increased as unemployment rose and EUI terms became more generous.
On the day of the meeting 5-year inflation expectations (TIPS spreads) were 1.23% (not far from what actually played out.) I found Kevin's observation on the extended UI to be particularly interesting. Yes, Yellen only regards it as raising unemployment by a few tenths of percent. But the program only involved an extra 13 weeks, and unemployment was only 6.1% at the time. When I later claimed that a 73-week extension of UI might have raised unemployment by 0.5% or so, all sorts of liberal commenters berated me for being heartless and stupid. "Do you really think the unemployed don't want to work?" Yes, I think that 1 out of every 200 Americans does not want to work. How many do you think don't want to work?
So Janet Yellen did not want to ease monetary policy, despite a worsening financial crisis, and despite an economy that was sliding into recession. (Unemployment had already risen by 1.6%, whereas any increase over 0.8% signals recession 100% of the time.) And despite inflation expectations being far below the Fed's target. And one of the factors (certainly not the only one) that caused her to want to hold off was the perception that some of the increase in unemployment was lazy bums who don't want to get off their butts and start working.
Don't take this post the wrong way. I'm not trying to criticize the DeLong/Yellen labor market model; indeed I think they are 100% correct. Rather I'm wondering what the heck has happened to American liberalism over the past 6 years? This incident feels like it came from another century, another millennium.