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What drives the unemployment rate?

Summary:
I was recently directed to an interesting Jason Douglas tweet showing a slowdown in UK investment—perhaps due to Brexit uncertainty: I was curious as to how this impacted Britain’s unemployment rate: Wait; shouldn’t there be three lines? Look again, the US and UK have almost identical unemployment rates, at least since 2012. In my view, investment shocks don’t have much impact on the unemployment rate. That’s why the recent slowdown in US investment (perhaps associated with the China trade war) has not impacted the unemployment rate in the US. In the Keynesian model, investment is quite similar to fiscal policy. Either expansionary fiscal policy or positive “animal spirits” among investors will lead to faster growth and higher employment. But does the data

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I was recently directed to an interesting Jason Douglas tweet showing a slowdown in UK investment—perhaps due to Brexit uncertainty:

What drives the unemployment rate?

I was curious as to how this impacted Britain’s unemployment rate:

Wait; shouldn’t there be three lines? Look again, the US and UK have almost identical unemployment rates, at least since 2012.

In my view, investment shocks don’t have much impact on the unemployment rate. That’s why the recent slowdown in US investment (perhaps associated with the China trade war) has not impacted the unemployment rate in the US.

In the Keynesian model, investment is quite similar to fiscal policy. Either expansionary fiscal policy or positive “animal spirits” among investors will lead to faster growth and higher employment. But does the data support that?

In 2014, the Japanese sales tax increase did sharply slow GDP growth for a quarter, but the labor market was almost entirely unaffected. The unemployment rate kept declining at the same rate, despite Keynesian scare stories about “recession”. (In contrast, Japanese unemployment rose sharply when NGDP fell in 2008-09.)

The case of the US austerity of 2013 was even worse for the Keynesians. Both the labor market and GDP did well, despite the budget deficit falling from $1050 billion in calendar 2012 to $550 billion in calendar 2013.

The Brexit shock probably slowed UK investment, and may have slightly slowed RGDP growth. But the labor market reflects monetary policy, and as long as policy keeps NGDP growth at a decent rate, the impact of these shocks on unemployment is negligible.

Of course that’s a big if. The Fed should cut rates by at least 25 basis points at its next meeting, to assure an adequate level of NGDP growth in 2020. Better yet would be 50 basis points, as they are still falling short of their 2% inflation target. The BOJ and ECB need far more expansionary monetary policies. I’d recommend they shift to level targeting and buy whatever it takes to hit the target.

PS. This doesn’t mean a slowdown in investment is not “bad”—it is. It’s just that the problem it creates is not unemployment; rather it’s slower growth in living standards.

HT: Mike Bird


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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