Employers Hiring Less & Paying More

As already noted the recent payroll survey data on jobs was rather weak. 121,000 new payroll jobs is insufficient to keep pace with a population growth of 140,000. However, wages last month grew at the fastest rate in 5 years.

The article notes that many analysts were predicting 175,000 new jobs and some had revised that estimate even higher prior to the release of the jobs report. So the news is a mixed bag. Further, there is the problem of inflation. If the Federal Reserve sees the increase in wages as a prelude to future increases in inflation the response might be to head it off via higher interest rates.

One could argue that the weak jobs number gives the Fed room to pause in rate increases. The problem with future rate increases is linked to mortgage rates and housing prices. The recent run up in housing prices linked with the rising interest rates could result in increased monthly mortgage payements which could very likely lead consumers to cutting back in other spending. Combined with high fuel/energy prices this could lead to a recession.

A rate increase could bump up mortgage rates enough to prompt homeowners to cut spending significantly, save more and tip the economy into recession, said University of Maryland economist Peter Morici, former chief economist at the U.S. International Trade Commission.

“The Fed could easily push the economy off of the cliff,” Morici said.

The last two recessions, in 1990-91 and 2001, followed repeated rate increases. Some analysts predict Bernanke will hold off on further increases, convinced by the jobs report that growth is slowing and wages are simply catching up to rising productivity.

On top of this is the fact that Bernanke is a new Fed chairmen and he’d like to establish a reputation as an inflation hawk.

This brings in some interesting economic work by Edward Prescott and Finn Kydland on economic policy that was one of the reasons they won the Nobel Prize in Economics. The basic idea is that a policy maker can’t commit to the optimal discretionary policy and people know this. The reasoning is as follows:

  1. The policy maker anounces an optimal policy (say zero inflation).
  2. The public believes this policy will be followed.
  3. Later the policy maker can improve social welfare by reneging on the policy.
  4. Since people are forward looking they don’t believe the policy to begin with because of number 3 above.
  5. The result is a sub-optimal outcome.

This result is known as time inconsistency.

The simplest stylized example is the college class with the grade determined by a single final at the end of the year. The professor announces the policy at the begining of the semester. Given the policy and assuming the students believe this, they study for the test. At the end of the semester, the best policy now is to renege on the initial policy and give no test. The reason is that since the students studied they will pass the test (assume a pass/no pass test) and thus the students are saved the trouble of taking the test and are hence better off. The professor doesn’t have to grade the test and is hence better off. Realizing that the professor will renege the students wont study hence they don’t learn the contents of the course. The typical way out of this is to announce that there will be a test and then actually give the test, but still this isn’t the best possible outcome as already noted.

The same problem applies for things like trying to lower the inflation rate. By reneging on the policy to lower inflation there could be more jobs which could improve social welfare. Thus, nobody believes the initial policy and a sub-optimal outcome results. To get around this some of the economic literature argues that central bankers might try to build a reputation of being an inflation hawk. One sure way to do this is to put the economy into a recession to prevent inflation from rising too fast. This sends the signal that the central banker is so concerned about keeping inflation under control that they will tank the economy in the short run.

Since Bernanke is the new Fed chairmen he may feel a need to establish his reputation and not worry about sending the economy into a recession.

Although the risk of recession is less than 20 percent, it jumps to 40 percent if the Fed raises rates next month, said Bernard Baumohl, executive director of the Economic Outlook Group in Princeton Junction, N.J.

“He knows it takes time for inflation to slow down, but it will slow down as the economy slows,” Baumohl said. “The one thing you don’t want to do is to overtighten.”

But Bernanke, who is still trying to make his own mark since replacing longtime Chairman Alan Greenspan earlier this year, has styled himself as an inflation fighter. “Bernanke is worried about establishing his credibility,” said Morici, who predicts a quarter-point rate increase to 5.5 percent in the Fed’s benchmark short-term rate next month.

And this anemia in the payroll survey isn’t something that is new as the article and I have noted.

The economy added 92,000 jobs in May and 112,000 in April, the Labor Department said, 3,000 more than previously reported. For each of the past three months, analysts expected more new jobs than were produced. Job gains of about 150,000 a month are needed to keep up with growth in the labor force, analysts say.

Add on that the expansion is fairly old as expansions go. According the NBER since 1945 the average length of expansions has been 57 months, just under 5 years. This doesn’t mean that next month we will enter a recession, but it is a possibility.

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Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. We may well enter a recession next month, but it is more likely to be cause by North Korea or Iran doing something incredibly stupid than the events of the normal business cycles. Have you shorted the market indices yet to take advantage of your predictions? To repeat an old joke, at some point in the future, will we find that you have successfully predicted 12 of the last 3 recessions?

    All snark aside, this reminds me a lot of Stephen Green warning us all for the last three years of the deflation that is just around the corner. One day he’ll be right.

  2. Steve Verdon says:

    Charles,

    Read the post again, and this time try to refrain from strawman arguments. I didn’t say the economy was going into recession, but that it might. Even 40%, is still pretty low and not good reason to run out and short one’s position.

  3. Steve, not to get all pedantic, but I don’t think I wrote that you wrote the economy was going into a recession. Admittedly, I implied that you wrote that, but then you were pretty strongly implying a coming recession as well. The following are all excerpts from your commentary:

    The recent run up in housing prices linked with the rising interest rates could result in increased monthly mortgage payements which could very likely lead consumers to cutting back in other spending. Combined with high fuel/energy prices this could lead to a recession.

    One sure way to do this is to put the economy into a recession to prevent inflation from rising too fast. This sends the signal that the central banker is so concerned about keeping inflation under control that they will tank the economy in the short run.

    Since Bernanke is the new Fed chairmen he may feel a need to establish his reputation and not worry about sending the economy into a recession.

    This doesnâ??t mean that next month we will enter a recession, but it is a possibility.

    My apologies if my comments seemed to imply something that I did not intend. I was just noting that your pessimism regarding the economy has been something of a recurring theme of late. Of course, as others have noted, economics is the dismal science.

  4. Steve Verdon says:

    Charles,

    Didn’t you participate in my last thread about the anemic payroll numbers? If not, go read what I wrote there in response to YAJ about the economy. That I see some possible problems looming for the economy doesn’t mean I’m pessimistic.

    For the first quote, there are two uncertain events. The first is the raising of interest rates, the other is impact on mortgage payments. The first must happen for the second to even be possible. In short, it is still an uncertain event.

    By the way, the first paragraph in the second quote is out of context. I was discussing how a central banker could build a reputation as an inflation hawk. That is certainly one way of doing it. It doesn’t follow that Bernanke has to use that method.

    As for the last one, you do realize that next month the expansion will be 57 months old. That makes it a fairly old expansion. Hence the comment.