Structural vs. Cyclical Unemployment Revisited: Doing Nothing Is Not a Smart Option

An update on the question of structural vs. cyclical unemployment, this time with respect to policy options for each. For background, see these previous posts:  on how economists define or distinguish between structural and cyclical and a look at the situation in 2011.  Time is short and specialization is efficient, so I’ll quote Mark Thoma on this (and he’ll quote Peter Diamond and Christie Romer):

I wish I’d remembered point three when I wrote recently about the difficulty of separating cyclical and structural unemployment. I was saying, essentially, the same thing that Peter Diamnond says here (via):

Second, for the current moment, the argument about the aggregate demand side is academic, in the negative sense of the word. Current estimates I have seen of how much of the increase in unemployment from a few years ago is “structural,” rather than due to inadequate aggregate demand, still leaves enough need for aggregate demand stimulation that it is clear what direction is needed for further policies.

Third, I am skeptical of the value of attempting to separate cyclical from structural unemployment over a business cycle…. The tighter the labor market and the more valuable the filling of a vacancy, the more a firm is willing to hire a worker who is a less good match, who may need more training…. [A] worker who might be viewed as structurally unemployed, as facing serious mismatch in the current state of the economy, may be readily employable in a tight labor market. The common practice of thinking about the extent of unemployment as a sum of frictional, structural and cyclical parts misses the point…. [D]irect measures of frictional or structural unemployment… dependent on the tightness of the labor market… have limited relevance for the role of demand stimulation policies. The idea that the US economy is not adaptable and capable of dealing with the need for skills and jobs to adapt to each other is peculiar, given the long history of unemployment going up and down. When the labor market is tight and firms have trouble finding workers, they reach out to places they have not looked before and extend training in order to find workers who can fill their needs. Supporting current stimulus policies as very good for the economy is entirely compatible with taking care to avoid future inflation.

Thus, no matter how you slice it or how you define it — and even with a very generous interpretation of the structural estimates — there is still plenty of cyclical unemployment (or, perhaps more precisely, employment that will respond to an increase in demand) to worry about, and plenty for policy to do.

But suppose that, contrary to what the estimates are telling us, there is a large, dominant, structural component. Does that mean we sit on our hands and do nothing? Nope, Christy Romer makes a point I’ve made many times. Even if the problem is structural, there are still things we can do to help:

There’s this debate going on over what the source of the unemployment is: Do we not have enough aggregate demand, or is it structural? What frustrates me is the advocates of the structural theory go from saying it’s hard to turn construction workers into nurses to saying we should do nothing. If you think our problem is structural, there are things we should be doing: money for training, or helping people get out of their mortgages, or massive investment in Detroit. I don’t believe that skills are the problem here, but if that’s your point of view, there’s still a lot we can do. Saying it’s structural is not the same as saying it’s not our problem.

No matter the cause, we’ve dropped the ball on the unemployment problem (and have yet to pick it up). As I said last week, “We have enough money to pay for military action in Libya, but not for job creation?” But Bob Herbert’s last column at the NY Times says it better:

Losing Our Way, by Bob Herbert, Commentary, NY Times: So here we are pouring shiploads of cash into yet another war, this time in Libya, while simultaneously demolishing school budgets, closing libraries, laying off teachers and police officers, and generally letting the bottom fall out of the quality of life here at home.

Welcome to America in the second decade of the 21st century. An army of long-term unemployed workers is spread across the land, the human fallout from the Great Recession and long years of misguided economic policies. Optimism is in short supply. The few jobs now being created too often pay a pittance, not nearly enough to pry open the doors to a middle-class standard of living. …

The U.S. has not just misplaced its priorities. When the most powerful country ever to inhabit the earth finds it so easy to plunge into the horror of warfare but almost impossible to find adequate work for its people or to properly educate its young, it has lost its way entirely. …

Millions and millions of people still unemployed, the prospects of a slow, slow recovery of employment ahead of us (along with the permanent damage that long-term unemployment brings about), and few people in Washington seem to care.

Unemployment vs. Inflation: Which is Worse? Part I

Macro economic policy making is often characterized as a trade-off between achieving full employment vs. achieving stable money (no significant inflation). This relationship or trade-off,to the extent it exists, is called the Phillips Curve.  [note: the stability and existence of a long-run trade-off is highly contested by some]. In this post, I want to look at the costs of missing our objectives on either.

In my macro classes I like to emphasize that an economy, any economy, wants to achieve at least 4 major objectives through policy:

  1. Overall growth (long run trend growth in GDP)
  2. Short- and Medium-run stability of growth (minimize the business cycle)
  3. Stable monetary and financial system (no significant inflation, no deflation, no financial crises)
  4. Full employment

Of these, it is often perceived that achieving both #3 and #4 may be problematic since the easy policies to achieve either run the risk  of making the other worse.  It is possible to achieve both, but it’s more tricky and requires more accurate policy moves. That brings us to the question of which way is the more serious error?  Not all dilemmas are symmetrical.  In other words, if we’re likely to make an error, which error should we prefer?  Yes, we may be stuck “between a rock and a hard place”, but if the hard place is material that’s likely to absorb some impact and let us survive with injuries, while hitting the rock represents certain death, I would definitely prefer policies that, if they are wrong, they tend to lead to the hard place over the rock.

So which is worse?  The rock of high unemployment?  Or the hard place of inflation?  In this post, I’ll offer some evidence for why high unemployment is the more costly problem.  In a later post, I’ll look at the costs of inflation.  For now let’s look at the costs of high unemployment below the fold:

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