The consequences of ultra-low US unemployment

The American labour market is entering largely unexplored territory

Gavyn Davies

Workers assemble sneakers at the New Balance Inc. manufacturing facility in Lawrence, Massachusetts, U.S., on Tuesday, July 31, 2018. The U.S. Census Bureau is scheduled to release factory orders figures on August 2. Photographer: Scott Eisen/Bloomberg
Workers assemble New Balance shoes in Lawrence, Massachusetts. US unemployment has been continuously falling since 2010 © Bloomberg

Investors may have become inured to the continuous decline in US unemployment since 2010, but the recent drop has been truly remarkable by postwar historic standards.

Last month, unemployment fell to 3.5 per cent of the labour force, a level not seen since 1969.

Furthermore, employment has been rising at an average rate of 170,000 a month in the past year.

Goldman Sachs economists calculate that the American economy needs to create only 100,000 extra jobs a month to match the rise in the labour force, and thus leave unemployment unchanged.

If job creation continues at this pace, the unemployment rate will fall further, reaching 3.3 per cent by the end of 2020.

This would be the lowest level since the Korean war.

By far the most important cause of ultra-low unemployment has been the recovery of aggregate demand in the economy, which has resulted in gross domestic product growth persistently higher than the growth of labour productivity. Consequently, unemployment from lack of demand has fallen by about 6 percentage points since 2009 (see box).

A second, and less significant, reason has been a decline in the natural rate of unemployment, which is the equilibrium rate that is consistent with stable inflation at any point in time.

This rate, determined by the supply side of the labour market, is estimated by the Congressional Budget Office to have fallen by 0.3 percentage points since the trough of the economic cycle in 2009.

In past cycles, a decline in unemployment below its natural rate has often been a signal that wage pressures are rising, quickly leading to higher price inflation and tighter monetary policy.

This should worry both the Federal Reserve and the financial markets.

A year ago, with unemployment dropping below the natural rate, Fed chairman Jay Powell seemed concerned that this pattern might reassert itself.

In June 2018, he said:

If central banks were instead to try to exploit the nonresponsiveness of inflation to low unemployment and push resource utilization significantly and persistently past sustainable levels, the public might begin to question our commitment to low inflation, and expectations could come under upward pressure.

          Fed chairman Jay Powell, June 2018

These concerns seem to have disappeared almost completely in recent months.

A series of dovish speeches on the labour market by Mr Powell and vice-chairman Richard Clarida culminated in Mr Powell saying two weeks ago:

Recent years’ data paint a hopeful picture of more people in their prime years in the workforce and wages rising for low- and middle-income workers . . . This is just a start: there is still plenty of room for building on these gains.

           Fed chairman Jay Powell, November 2019

Instead of worrying about the possible inflationary consequences of excess resource utilisation in the labour market, as he did a year ago, the chairman is now embracing a further tightening in the jobs market and welcoming the consequences, including higher wage inflation for low paid workers.

This important shift in Mr Powell’s perception of the balance of risk has stemmed from several factors.

- Consumer price inflation, the Fed’s targeted variable, seems stuck at low levels, with little indication that the tightening in the labour market is having any adverse impact, although wage inflation is now clearly rising.

- Fringe workers, especially of prime age in disadvantaged groups, are being drawn back into employment by the buoyancy of labour demand. Mr Powell has hinted that falling unemployment among black, Hispanic, disabled and less educated people is reducing the overall level of inequality in the economy, and has said that wage disparities among employed workers are narrowing after two decades of widening.

- The tightness in the labour market may be inducing employers to find new ways of increasing staff efficiency, thus permanently boosting productivity growth and potential GDP. This rise in productivity is analogous to what happened near the peak of the 1990s economic upswing, when Alan Greenspan as Fed chairman allowed the labour market to “run hot” for several years. He correctly believed that inflation would remain under control.

These social and economic reasons for following Mr Greenspan now seem compelling to a large majority on the Federal Open Market Committee.

Hence, the risk that markets will face a hostile Fed in 2020 has been sharply curtailed.

However, this story has not always ended well. Ultra-low unemployment in the late 1960s eventually led to much higher inflation, when Fed chairman Arthur Burns was pressured by the presidential re-election campaign in 1972.

That turned out to be a major, inflationary mistake.

Chairman Jay Powell will not want to let President Donald Trump lead him down the same dangerous path.

Why US unemployment is nearing all-time post war lows

Since the US unemployment rate peaked at 10.0 per cent in October 2009, it has fallen by 6.5 percentage points. Over the same period, the natural rate of unemployment (estimated by the Congressional Budget Office) has dropped from 4.9 per cent in 2009 Q4 to 4.6 per cent today.

The natural rate of unemployment, less the actual rate, provides an estimate of demand-deficient unemployment, or the “unemployment gap”.

This gap has shrunk from minus 5.1 per cent at the trough of the recession to plus 1.1 per cent now.

The unemployment gap measures the degree of excess utilisation of resources in the labour market.

It is usually closely related to the output gap, which is an indicator of resource utilisation in the whole economy.

At present, both the unemployment gap and the output gap are positive, suggesting that inflation pressures should be rising throughout the economy.

So far, these pressures are not becoming apparent, either in price inflation data or in inflation expectations.

However, based on the behaviour of the US economy in past cycles, the Fed is taking a calculated gamble that inflation will remain subdued for longer than usual.

How Trolls Overran the Public Square

Since the invention of writing, human innovation has transformed how we formulate new ideas, organize our societies, and communicate with one another. But in an age of rapid-fire social media and nonstop algorithm-generated outrage, technology is no longer helping to expand or enrich the public sphere.

J. Bradford DeLong


BERKELEY – Since 1900, human technology and organization have been evolving at a blistering pace. The degree of change that occurs in just one year would have taken 50 years or more before 1500. War and politics used to be the meat of human history, with advances in technology and organization unfolding very slowly – if at all – in the background. Now, the inverse is true.

The impact of technological innovation on the marketplace of ideas has brought about some of the most consequential changes. The shift from the age of handwritten and hand-copied manuscripts to that of the Gutenberg press ushered in the Copernican Revolution (along with almost two centuries of genocidal religious war). Pamphlets and coffee houses broadened the public sphere and positioned public opinion as a powerful constraint on political rulers’ behavior.

As John Adams, the second president of the United States, later pointed out, the “[American] Revolution was effected before the war commenced … in the minds and hearts of the people.”

The decisive intellectual battle, we now know, was won by the English-born printer Thomas Paine’s pamphlet Common Sense. Still, even during the revolutionary period, the pace of change was far slower than it is today. In the space of just two human lifetimes, we have gone from mass-market newspapers and press lords to radio and network television, and then on to the Internet and today’s social media-driven public sphere. And most of us will live long enough to witness whatever comes next.

There is now a near-consensus – at least among those who are not completely steeped in social-media propaganda – that the current public sphere does not serve us well. “Social media is broken,” the American author Annalee Newitz wrote in a recent commentary for the New York Times. “It has poisoned the way we communicate with each other and undermined the democratic process. Many of us just want to get away from it, but we can’t imagine a world without it.”

Western societies have experienced a similar sentiment before. In the 1930s, my great-uncles listened to their elders complain about how radio had allowed demagogues like Adolf Hitler, Charles Coughlin, and Franklin D. Roosevelt (that “communist”) to short-circuit the normal processes of public discourse. No longer were public debates kept sober and rational by traditional gatekeepers.

In the new age of broadcast, unapproved memes could spread far and wide without interference. Politicians and ideologues who may not have had the public interest in mind could get right into people’s ears and hijack their brains.

Nowadays, the problem is not a single demagogue, but a public sphere beset by swarms of “influencers,” propagandists, and bots, all semi-coordinated by the dynamics of the medium itself. Once again, ideas of dubious quality and provenance are shaping people’s thoughts without having been subjected to adequate evaluation and analysis.

We should have seen this coming. A generation ago, when the “net” was limited to universities and research institutes, there was an annual “September” phenomenon. Each year, new arrivals to the institution would be given an email account and/or user profile, whereupon they would rapidly find their online communities. They would begin to talk, and someone, inevitably, would get annoyed. For the next month, whatever informational or discursive use the net might have had would be sidelined by continuous vitriolic exchanges.

Then things would calm down. People would remember to put on their asbestos underwear before logging on; they learned not to take the newbies so seriously. Trolls would find themselves banned from the forums they loved to disrupt. And, in any case, most who experimented with the troll lifestyle realized that it has little to recommend it. For the next 11 months, the net would serve its purpose, significantly extending each user’s cultural, conversational, and intellectual range, and adding to the collective stock of human intelligence.

But as the Internet began to spread to each household and then to each smartphone, fears about the danger of an “eternal September” have been confirmed. There is more money to be made by stoking outrage than by providing sound information and encouraging the social-learning process that once taught net newbies to calm down. And yet, today’s Internet does offer valuable information, so much so that few of us could imagine doing without it. To access that information, we have tacitly agreed to allow the architects at Facebook, Twitter, Google (especially YouTube), and elsewhere to shape the public sphere with their outrage- and clickbait-generating algorithms.

Meanwhile, others have found that there is a great deal of money and power to be gained by shaping public opinion online. If you want to get your views out there, it is easier to piggyback on the outrage machine than to develop a comprehensive rational argument – especially when those views are self-serving and deleterious to the public good.

For her part, Newitz ends her recent commentary on a hopeful note. “Public life has been irrevocably changed by social media; now it’s time for something else,” she writes. “We need to stop handing off responsibility for maintaining public space to corporations and algorithms – and give it back to human beings. We may need to slow down, but we’ve created democracies out of chaos before. We can do it again.”

Such hope may be necessary for journalists these days. Unfortunately, a rational evaluation of our situation suggests that it is unjustified. The eternal September of our discontent has arrived.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

Japan and the Art of Making the Same Mistakes Over and Over Again

A sales-tax increase has once again dented the Japanese economy more than the government expected; the country can do better

By Mike Bird

For the third time, Japan has increased the country’s sales tax when a tightening of fiscal policy wasn’t merited. For the third time, the economic hit has been greater than expected.

This week, the Japan Center for Economic Research suggested the Japanese GDP contracted 3.7% in October from its level a month earlier, as the government increased the sales tax from 8% to 10%. The forecast is the worst since the last time the government made exactly the same mistake and raised the tax from 5% to 8% in 2014.

It’s not just the rise in sales tax; it’s also the effect of Typhoon Hagibis, which hit in October. But there were already signs of a greater-than-expected problem in September before the storm began.

Japan in October raised its sales tax to 10% from 8%. Photo: kim kyung hoon/Reuters 

September retail sales at department stores surged 22.8% year over year, as consumers front-loaded purchases. The rise in March 2014 was only slightly larger, at 25.2%.

The Japanese government’s Economy Watchers Survey also showed a plunge in expected future conditions during September to the worst reading since March 2014. It’s impossible to tease apart exactly how much of the decline was caused by weather, and how much by policy.

But that does little to change the fact that the increase was misguided.

History repeats itself in Japanese economic policy, first as tragedy and then as farce. Given that tax increases in both 1997 and 2014 had similar effects, successive governments must one day stop acting surprised when raising the sales tax derails an economic recovery.

International bodies have been little help: The International Monetary Fund last month called for the consumption tax to be raised by another 5 percentage points in the next decade.

In the aftermath of this downturn, the government might also reconsider its tortured fiscal policy in general: The priority it places on debt sustainability is far too high, given that its net interest payments run to well below 1% of nominal GDP.

Even if rising government debt levels were a concern, it should be clear by now that repeated tax hikes actually contribute to the pile, by continually suppressing demand and further ingraining expectations of low nominal growth.

A good first step to fixing Japan’s neuralgic relationship with government spending would be not to let next year’s fiscal stimulus disappear into the ether. Japanese governments have a habit of overstating stimulus efforts by including non-stimulus spending and private investment incentives in headline figures.

Despite repeated errors, it’s never too late to start making things right. Japan should pursue a real fiscal stimulus, ignore the IMF and put the prospect of more sales-tax increases onto the garbage heap of economic policy ideas.

Pearl Harbor and the Strategy of Economic Sanctions

By: George Friedman

There have been many lessons drawn from the Japanese attack on Pearl Harbor. One was that wars need not begin according to international law. Another was that attacks can be unexpected and that constant vigilance is necessary. Still another was that underestimating an enemy can be catastrophic. 

And yet another was that failure to understand how new technology changes the nature of war can be disastrous.

The list of lessons learned is of course longer than the list of lessons remembered, one of which is particularly germane at this moment: When imposing economic sanctions, the more powerful the sanctions, the greater the pressure on your adversary to strike back. 

At a time when the U.S. is shifting from the use of military force to the use of economic power, the lesson of why Pearl Harbor was attacked needs to be considered carefully.

War Plans

Prior to World War I, Japan was the leading industrial power in the Western Pacific. After World War I, Japan expanded its military sphere of influence. It had sided with the Anglo-French alliance during the war, and as a reward, German holdings in the Western Pacific were turned over to it. This paralleled the growth of Japanese naval power, and it seemed that the American position in the Pacific, built around Hawaii and the Philippines, was in danger.

The United States had developed a series of global war plans after the end of World War I. War Plan Black assumed a war with Germany. War Plan Red assumed a war with Britain (not quite as insane as it sounds, since the U.S. had been dueling with Britain over control of the North Atlantic since its founding). The plan that was taken most seriously was War Plan Orange. For the U.S. Navy, War Plan Orange was the basis of all planning between 1920 and 1941. 

It assumed that the Japanese would move against the Philippines in order to take control of the resources in present-day Indonesia and Southeast Asia. The U.S. assumed that Japan could not achieve its goals unless the Philippines was in Japanese hands, since ships in the Philippines could cut the flow of supplies to Japan. 

The U.S. plan was to accept the conquest of the Philippines and then send the U.S. Pacific Fleet, a massive force built around battleships, westward to force the Japanese navy into a decisive battle that the U.S. fleet would win.

The entire premise behind War Plan Orange was that the Japanese had a hunger for raw materials. 

That was the decisive reality. Japan was a significant industrial power but was bereft of minerals at home. They had to import nearly all the raw materials needed for their domestic industry and defense. 

The U.S. assumed that at some point Japan would move south and intervened in China to undermine such a move. The U.S. national defense strategy was built not on Europe but on Asia, and on the assumption that Japan would move south.

The Japanese did not move beyond Japan until 1940. They had treaties with both the Netherlands and the French to supply a wide range of raw materials. But the collapse of France and the Netherlands put in question the value of those treaties and posed an existential problem for Japan. Japan saw Indochina as unable to guarantee compliance with the treaties, and so it moved into Indochina. 

The United States believed that if it simply accepted the move, it would guarantee Japanese control of China and open the door for their expansion into the South Pacific and the Indian Ocean basin.

The U.S. solution to this was actions they regarded as a means short of war. It halted all sale of U.S. oil and scrap metal to Japan and had U.S. agents buy up Indonesian oil not for shipment to the United States but to prevent Japan having access to it. 

The Americans demanded that Japan withdraw not only from Indochina but from China as a whole. 

The U.S. sought to put Japan in an impossible spot on the assumption that an aggressive Japanese response would trigger War Plan Orange, force a confrontation with the Japanese fleet somewhere between Taiwan and Borneo, and finish the Japanese.

The Japanese were familiar with the concepts behind War Plan Orange due to numerous naval war games that simulated it. The danger of peacetime readiness is that it reveals the kind of war you expect to fight. 

The Japanese knew that if they failed to comply with U.S. demands, U.S. sanctions would cripple them at best. But if they did comply with U.S. demands, they would be reduced to an American vassal state.

Their third option was war, but knowing the specifics of U.S. war plans, they would have to fight the war in a way that would deny the U.S. the opportunity to bring its fleet of battleships to bear. They knew that the U.S. expected to lose the Philippines but that the Americans intended the loss to lead to the destruction of the Japanese navy. 

The Japanese understood the threat that resisting or complying with U.S. sanctions posed, and that war waged as the U.S. expected it to be waged would lead to defeat. The Japanese had hoped to avoid war with the United States, but American sanctions convinced them that the U.S. intended to break Japan. What the U.S. saw as an alternative to war the Japanese saw as forcing their hand.

Most important, they would not fight as War Plan Orange expected. They would not engage the American fleet in a surface battle. Rather than serving as the culmination of war, they decided they had to engage the U.S. fleet as the first act of war. 

Thus, they chose to use aircraft carriers as the main strike force that would approach from a completely unexpected direction (from the northwest), and try to fight the decisive battle not with a surface fleet against a surface fleet, but with naval air power against a surface fleet in port.

To emphasize, the Japanese did not intend or expect war with the U.S. until the U.S. put sanctions on them. Japan saw itself as maintaining access to raw materials guaranteed by treaty. It saw U.S. sanctions as an attempt to compel Japan to capitulate without engaging in war and capitulation as permanent subordination to the United States. 

Under this pressure, they chose war but deliberately avoided the war the U.S. had planned. They ultimately lost by underestimating the recuperative power of the United States. But they understood that their core geopolitical problem was lack of resources, which compelled them to capture Southeast Asia.

Economic Warfare

The Japanese could not back off; they had to be aggressive. The United States saw the challenge posed to U.S. security by Japan’s imperative as requiring the imposition of pressure that challenged Japan’s fundamental interests. 

Rather than capitulating, the Japanese chose to launch a war in a totally unexpected way. The U.S. had constantly signaled how they would wage a war with Japan, and the Japanese adjusted their own war plan in ways the U.S. didn’t expect. 

The Japanese were aware of the extremely high risk of the war, but thought the U.S. would negotiate rather than try to invade Japanese-held territory. Japan viewed war as less risky than sanctions. Both sides were wrong. The Americans did not anticipate the Japanese response to sanctions directed at fundamental Japanese interests. The Japanese did not understand that after Pearl Harbor, the U.S. would wage war asking and giving no quarter.

American strategy during and especially after the Cold War has depended heavily on the use of sanctions. Over the past decade, the U.S. has shifted its posture away from military action toward economic warfare. In China, Iran, Russia, Turkey and numerous other countries, the first American response to divergent interests is not to wage war but to take what is seen as a less threatening step of imposing sanctions. 

The United States produces nearly 25 percent of the world’s gross domestic product and is the largest importer in the world. This gives it significant options and forces other countries to consider whether complying with U.S. demands is less harmful than the risk of resisting those demands.

The Japanese example is a classic case in which sanctions, deliberately targeted against a country’s core interests, caused the country to choose a military option rather than to duel economically. Tokyo realized it would lose the latter and had a chance with the former. The core lesson of Pearl Harbor was not that economic pressures aren’t a valuable tool, but that the assumption that the adversary would not choose a military response is uncertain. 

The more effective the sanctions, the greater the chance of a military response. The assumption that the adversary has no military options may be true given expectations of capabilities. But, as with Japan, effective sanctions can compel the other side to develop innovative and painful solutions.

The danger of War Plan Orange was that it drilled into a generation of naval officers a perception of how a war would be fought. The combination of effective sanctions and the gift of a clear understanding of American war plans caused the Japanese to adjourn the economic confrontation and commence an unexpected opening to war.

In undertaking economic sanctions, there must also be parallel and unexpected military options on the table. The predictability of U.S. operational principles allows the enemy to innovate unexpectedly. The assumption that the economic dimension will remain economic because we wish it to fails to understand one of the main lessons of Pearl Harbor.

This is not an argument against economic sanctions; they have been used for decades. It is a warning to carefully select who they are directed against and how they are applied. They can create a situation where the sanctions are so effective that war can seem like an attractive alternative. If such sanctions are required, the U.S. should not expect the enemy to go to war in a way that is most advantageous to the United States. 

As with Pearl Harbor, the enemy will strike where we least expect and as hard as possible. The more desperate the adversary becomes, the more the military must anticipate an unexpected response.