South By North Strategies, Ltd.

From a recent speech by Christina Romer of the Council of Economic Advisers …

My first and most fundamental point is that when it comes to the economy we are very far from normal.  The unemployment rate is currently 9.7 percent.  I find it distressing that some observers talk about unemployment remaining high for an extended period with resignation, rather than with a sense of urgency to find ways to address the problem.  Behind this fatalism, there seems to be a view that perhaps the high unemployment reflects structural changes or other factors not easily amenable to correction.  High unemployment in this view is simply “the new normal.”  I disagree.
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The high unemployment that the United States is experiencing reflects a severe shortfall of aggregate demand.  Despite three quarters of growth, real GDP is approximately 6 percent below its trend path.   Unemployment is high fundamentally because the economy is producing dramatically below its capacity.  That is, far from being “the new normal,” it is “the old cyclical.”

Regarding long-term unemployment …

But, this rise in long-term unemployment is readily explained by the prolonged collapse of aggregate demand.  When hiring rates are very depressed, workers who lose their jobs are unlikely to find work quickly, and thus face a substantial chance of becoming long-term unemployed.  This effect is compounded by the fact that exit rates from unemployment, both in normal times and in recessions, are typically lower the longer a worker has been unemployed. This makes it even more likely that those who do not find work quickly will have long spells of unemployment. Thus, the rise in long-term unemployment is the almost-inevitable consequence of the severe recession.  We do not need to appeal to any underlying structural changes to understand it, and there is every reason to expect that long-term unemployment will come back down when aggregate demand recovers.

On whether high unemployment is a structural problem …

In short, in my view the overwhelming weight of the evidence is that the current very high — and very disturbing — levels of overall and long-term unemployment are not a separate, structural problem, but largely a cyclical one.  It reflects the fact that we are still feeling the effects of the collapse of demand caused by the crisis.  Indeed, at one point I had tentatively titled my talk “It’s Aggregate Demand, Stupid”; but my chief of staff suggested that I find something a tad more dignified.

Regarding potential next steps …

One targeted measure that is likely to be very effective is additional fiscal relief to the states.  At this point, almost all of the adjustment in states’ budgets is coming from changes in spending and taxes, not changes in their rainy-day funds. As a result, relief is likely to alter states’ spending and tax decisions quickly.  By preventing tax increases and spending cuts, this relief raises income and employment relative to what it otherwise would be. The President has therefore called for additional funds to support state and local governments.  This measure has been endorsed by policymakers of both parties.