Monetary Morphine and the Job Market

By Pablo Paniagua

Monday, April 2nd

Ben Bernanke, the Fed Chairman, stated this week that the Fed would leave the door open for further monetary easing for the years to come, in an effort to support the Job Market and try to contain the unemployment rate. As well as an extended endeavor to maintain the full employment objective established in the Feds baffling dual mandate, along with the stability prices. The relevant question at this point would be if further monetary easing will help the job market in the long run or not. A key issue to understand this problem is to recognize first why the US has a high unemployment rate in the first place. The recession might be the common answer. Indeed, the recession has pushed companies all around the world to diminish their employment base and cut cost, leading to a short term shock in global job markets. This distress led to a sharp increase in the unemployment rate since 2007. However shocks are not always transitory or easy to revert, especially if the one we are dealing with came from the biggest leverage recession since the Great Depression. Indeed the negative upset in the job market could be seen as a dual effect that needs to be analyzed with more accuracy. The first job market effect of a negative economic recession shock is mostly cyclical and is a common element in all sort of negative distresses and mild recessions. Especially those linked with massive debt restructuring and deleveraging; both from companies and the consumers. This usually leads to a huge contraction in investments and consumption. The process unfortunately leads to a cyclical unemployment effect in the short run; which is the normal answer for the economy to deal with this contraction and deleveraging. In this kind of cases however, when the economy experiences mild slumps or consumer led kind of contraction. Monetary policies kind of interventions can indeed do some aid. They can stimulate the economy in the short term and create a positive virtuous circle for consumption and investment that might lead to diminishing the unemployment rate. Please become aware of that this is only true and effective when the economy has experience a mild recession or contraction. Not when the economy has experience a huge and catastrophic credit crises; a long with an incredible misallocation of factors of production in some sectors of the economy (like the housing and constructions markets). Bernankes word this week indeed make us think that he believes we are in the former kind of recession, rather that the latter; and more monetary easing can indeed help the job market, since (he thinks) is after all a cyclical problem, rather than a huge structural misallocation of the working American class in some sectors of the economy. This improperly allocated investments and factors of production were due to a huge monetary increase led by the former Fed chairman Mr. Allan Greenspan for more than 15 years. It would not be difficult to grasp the irony in the job market puzzle. This is that, the Fed thinks can help the unemployed through more monetary stimulus and further government intervention; when it has been showed that this sort of intervention in the economy for the last couple of decades is what caused huge malinvestment and a dreadful job allocation in bubble sectors of the economy in the first place. Those bad signals given by policy interventions to the investors and to workers, will eventually transform in nothing more than in an economic crisis and structural unemployment, which cannot respond any further to more Monetary Morphine.

The Second effect in the job market as we already mentioned is strictly structural and it is more difficult to deal and to pinpoint by monetary policy that the previous one. Structural problems in the job market reflect far deeper problems. Some of these problems identify by economists are: the existing mismatching between the skills that workers have or developed and the ones that the market requires at a given time. In some other cases some workers stay so long out of work that they become effectively unemployable, implicating that their skills erode over their time being unemployed. Economist calls the process of permanently and stick unemployment hysteresis, which is a term to reflect the long-term unemployment experienced in Europe in the early 80s. Evidently the last crisis suggests that the US might be experience a problem of this sort, which was catalyzed by the massive intervention of the money supply that gave investors and workers the wrong signals to where to direct their economic decisions. This conducted them in mass to specific sectors of the economy leaving them consequently, trapped with the skills they developed, once the bubbles in those sectors burst. It is relevant to address the fact of how discretionary policies lead big parts of the population to make the wrong decisions towards their careers or investments, which are only unfortunately revealed once the misallocations are corrected by market forces. Leaving the, now unemployed workers entrap with skills that were sustained and demanded only trough monetary folly. Undeniably this huge monetary expansion and the possibility of even further intervention is not going to improve the Job Market any further, as we have seen the problem was monetary intervention in the first place, so this time is unlikely that will be the solution; especially if the problem is rooted in the distorted structure of the economy. Even so this large expansion of the quantity of money (as shown in the chart on page 3.) will bring more risks rather than improvement. Once the massive quantity of fiat money will be finally pour in to the real economy, it will create further distortions in the structure of production and more malinvestment in the previous bubble sectors of the economy as well as higher inflation in the long run. Has we have experience in the last 3 decades lower interest rates and bloated fiat money is the mother of all depressions. As John Taylor wrote this week in the WSJ: By replacing large decentralized markets with centralize control by a few government officials, the Fed is distorting incentives and interfering in the price discovery with unintended consequences throughout the economy; Mr. Taylor is right, but not only will interfere in the price discovery but also will interfere any further (if that is possible) with the possibility of cleaning malinvestment and purging unsustainable markets, affecting the possibility of reestablished spontaneous order and natural balance in the job market. In conclusion further money printing will maybe boost some assets prices, specially the stock market and will definitely help banks to clean their balance sheets and became more willing to lend in the future. The risk here however, is that markets and asset classes will become dependent and hook on more monetary stimulus like patients became dependant on morphine, but the marginal effectiveness of the stimulus are diminishing over time. This will lead the Fed towards a dead end game in the money easing. However this stimulus scheme will end; the job market restructuring will be far away from the monetary policy reach.

Chart: Monetary stimulus by the Fed

Source: Federal Reserve Board H.4.1. and WSJ.