Part I: The Fed is Competent? Part II: The Natural Rate of Unemployment Part III: Bernanke, Blinder, and Underpants Gnomes Professor Blinder writes: "All in all, it looks like the nation and the world need an Economics 101 refresher. So let's start with the basics." All in all, it looks like Professor Blinder needs an Economics 101 refresher too. So let’s start with the basics. There are three types of unemployment: (1) frictional, (2) structural, and (3) cyclical. I am frictionally unemployed if I leave my current job and take time off before starting my new one. I am structurally unemployed if I lose my job to globalization or minimum wage increases, etc. I am cyclically unemployed if the economy is in recession. Keynes referred to cyclical unemployment in proposing his solutions. The Fed might be gravely mistaken to assume that today’s high, persistent unemployment rate is purely cyclical. The Fed can only impact cyclical unemployment, not structural or frictional. The sum of frictional and structural unemployment is the natural rate of unemployment. The Fed cannot alter this. There are many reasons why structural unemployment rather than cyclical unemployment might be at play:
- Exchange rates are more volatile: unpredictable monetary policies and debt crises are the cause. If I am in an industry that relies heavily on exports, I am in danger of unemployment.
- Health care reform: the costs have yet to be determined and increase employment costs. Needless to say, employers care about the total costs of hiring employees, not just the money wage/salary they pay workers. This uncertainty overwhelms the tiny tax credits offered in the stimulus package.
- The housing market is still sick. If people can’t move easily, labor mobility is constrained. It’s more difficult for me to find work if I can’t move.
- Higher, extended unemployment benefits reduce the incentive to be employed, at the margin.
- The Dodd-Frank Act also imposes numerous uncertainties on the financial sector. This complicates the process of linking savers with investors. Consequently, investment is curtailed and higher unemployment results.
- The uncertainty about the capital gains tax rate didn't help. Increasing taxes on capital decreases capital accumulation (investment). It does not help it. If productivity-increasing equipment costs me $200,000 and I’m willing to pay $250,000 for it, that’s great! If I have to pay a $60,000 tax on it, that’s bad: The equipment now costs me $260,000 and I was only willing to pay $250,000 before. Now I won’t buy it. I am worse off. The equipment supplier is worse off. The employees of the equipment supplier are worse off because they’ll need fewer workers for production.