The Fall conference for the Brookings Papers on Economic Activity recently concluded, and we’ve learned a lot about topics including: how long earnings losses persist after getting laid off in a recession; where policy can be most effective in helping small businesses grow and hire; how much extending unemployment insurance has impacted the unemployment rate during the Great Recession; the effectiveness of the Federal Reserve’s quantitative easing programs; and the different monetary policy paths of the central banks of U.S. and Sweden during the recent recession.
Let’s start with a paper by the University of Chicago’s Steve Davis and Columbia’s Til von Wachter entitled “Recession and the Costs of Job Loss.” The message of this new paper, is, quite bluntly, something we already knew — that losing your job sucks — but that it really, really sucks if you lose your job during a recession. The authors follow people who have lost their jobs as a result of a plant closing or some sort of general retrenchment—which is pretty much what we have been seeing these past few years—and then they follow these workers over a 20 year period. What they found is that not only does your income fall maybe 30% or 40% in the year in which you lose your job, but it actually remains 20% lower even 20 years later. So these workers are not just poorer the year of the lay-off, they are a whole lot poorer for a whole lot longer than anyone thought. They quantify this income loss and it’s eye-popping: during economic good times, if you get fired your future earnings (its future value) falls by about $65,000. But during a recession, it could be twice that large — a loss of maybe $120,000.
The big message from Lars Svensson in “Practical Monetary Policy: Examples from Sweden and the U.S.” is that central bankers make mistakes. Bear in mind, he is a central banker himself — Deputy Governor of the Swedish Central Bank (Sveriges Riksbank), so he has been at the table as they are making monetary policy over there, and he has also been closely following monetary policy here. Svensson not only says central bankers do indeed goof, but that they did over the past several years in response to the financial crisis and recession. Comparing the U.S. and Sweden, he says there has been a violation of what any central banker should do: if inflation is forecast to be below your target and unemployment is forecast to remain above your target, you should reduce interest rates. But neither Sweden nor, to a lesser degree, the United States, followed this policy.
The small business emperor has no clothes. OK, that’s a bit stark, but let’s dig into the findings of a paper by Erik Hurst and Benjamin Pugsley in “What do Small Businesses Do?” Policymakers in Washington are intensely focused on “small business” as the solution to our current economic woes. The research says there is really nothing there — the emperor has got no clothes. Once you look carefully at the data to see who the small businesses actually are, you see that they are not for the most part innovators, nor job creators. Small businesses are barbers, hairdressers, real estate agents and lawyers. They are not entering into these industries with any great goals of new patents or of new innovations — the things that would push economic growth in the future. Instead, the majority have no intention of growing or hiring. So what we need policy to focus on are not all small businesses but really a small subset — the entrepreneurs.
The extension of unemployment benefits has been controversial in recent times, and many are concerned that these benefits may have harmed the incentive for people to try to find work. But a new paper by Jesse Rothstein called “Unemployment and Job Search in the Great Recession” finds that these benefits haven’t really impacted the unemployment rate much at all. By their estimate, perhaps it is 0.3 percentage points higher. Interestingly, Rothstein finds that at least half of that increase is probably due to people staying in the labor force, rather than dropping out. So the total effect on jobs it, is an even smaller effect. In fact, as we start to emerge from the recession, these extensions in unemployment insurance may even turn out to be beneficial: they have kept people in the pool of unemployed, rather than outside the labor force. When the jobs return, these workers are going to be in a position to get back to work.
And finally, we had a timely paper, given the Fed’s most recent announcement of a new Operation Twist, that looks at how recent Fed action has impacted the economy. Arvind Krishnamurthy and Annette Vissing-Jorgensen analyze “The Effects of Quantitative Easing on Interest Rates,” finding that these policies are not only effective for what they actually do to different interest rates, but that also the Fed can help the economy with words alone without taking action. The authors look at the first two episodes of the Fed’s attempts to impact interest rates — QE1 and QE2 — and find that it is not just the Fed’s buying of bonds, but it is the ability of the Fed to shape the expectations of the market that really drives the biggest effects of quantitative easing. Basically, if the Fed says ‘we want long-run interest low and we have a big pile of money right here that we are going use to do that,’ they ultimately don’t have to use the money because the markets understand that they could always use that money if needed, and so long-run interest rates fall very quickly.
Sentiment inside the Beltway has turned sharply against China. There are many issues where the two parties sound more or less the same. Trump and others in the administration seem heavily invested in a ‘get very tough with China’ stance. It’s possible that some Democrats might argue that a decoupling strategy borders on lunacy. But if Trump believes this will play well with his core constituencies as his reelection campaign moves into high gear, he will probably decide to stick with it, if the costs and the collateral damage seem manageable. But that’s a very big if, especially if the downsides of a protracted trade war for both American consumers and for American firms become increasingly apparent.