Reflections on unemployment, inflation and the FED

The US Federal Reserve has achieved its inflation target, current inflation rates are higher than the target inflation and are making up for inflation rates that were too low in the past. We try to show why further expansionary measures are unlikely to have much positive impact on employment, but are only likely to fuel inflation. Finally, we turn to the question of whether Asterix and Obelix will succeed in beating the Romans.

The rise in inflation in recent months is proving to be more persistent than expected for many (not for the author). Will central banks now fight inflation?

 

FED inflation target reached

This poses a dilemma for central banks. The inflation target has been reached in the US: current inflation has exceeded the target inflation rate (July 2021 +5.4% yoy), average inflation is thus rapidly approaching the desired 2%. The rise in the inflation rate and the inflation indicators suggest a rapid tapering.

FED has already done everything “central bankable” to fight unemployment

To be sure, the goal of an appropriately high level of employment has probably not yet been achieved. However, as will be shown below, monetary policy has already done almost everything it can to ensure low unemployment. A further increase in employment will probably have to be achieved by other means rather than expansionary stimulus policy.  The following chart shows the number of job openings in blue and the number of job seekers in black since 2000. Currently, the supply of labor (companies looking for workers & employees) is higher than the demand for labor (unemployed looking for a job).

 

The graph below shows the number of people looking for work in black and the number of jobs available in blue.

Chart 1: Number of job seekers in thousands in black and number of vacancies in thousands in blue

 

 

Currently high structural unemployment

It is noticeable that so-called “mismatch unemployment” is currently unusually high. This form of unemployment occurs when companies expect skill profiles for their vacancies that are matched by only a few applicants in the unemployment pool. In other words, a better profile of the unemployed, as employers would like, would lead to a lower unemployment rate.

 

Structurally unemployed do not exert wage pressure

Normally, a high number of unemployed people together with a high number of jobseekers means that wages do not rise much or even fall, as jobseekers undercut each other and employers have a free choice between many suitable candidates. This is not true with “mismatch unemployment.” Employers will not hire unsuitable candidates even if they would be willing to work for very little pay or salary. As an exaggerated example, a vacancy for a lung surgeon will not be filled even if a waiter or waitress would be willing to do the job for $1 per day. Thus, the “mismatch unemployed” do not have a wage inflation dampening effect. Ergo, the “mismatch unemployed” also do not have a dampening effect on consumer price inflation.

 

Structural unemployment cannot be combated by expansionary monetary policy

If so-called “mismatch unemployment” is high, it cannot be combated by an expansionary monetary policy. Why? Because the following sentence is not only wrong, it is absurd: “The Fed, by further lowering interest rates and expanding its balance sheet even more aggressively, managed to improve the educational profile of many jobseekers so that it matched employers’ requirements and successfully filled all vacancies.

Logically, economic policy is largely ineffective against “mismatch unemployment”. Investments in education, schools, universities can be effective, but often pay off only after years.

 

That is why monetary policy has done “almost everything” it could against unemployment, which remains too high. Further expansionary measures would no longer lead to a significantly lower unemployment rate, but “only” further fuel inflation. For experts: this would represent a shift in the wage Phillips curve. Any unemployment rate would correspond to higher wage inflation due to the rise in “mismatch unemployment”, the short-term trade-off between low unemployment and high inflation would have worsened.

 

Will the FED fight high inflation rates? No, of course it won’t. It’s just going to pretend…

In all likelihood, the FED will only pretend to fight high inflation rates. The FED presidents are “acting”. Why? It is the FED’s unspoken goal to generate unexpectedly high inflation. It wants to generate high realized inflation while inflation expectations are low so that the government can deleverage, or worse, borrow further at record low interest rates (since investors have low inflation expectations that are not built into higher interest rate demands). Therefore, on the non-open-ended honesty scale (maximum score = -100% if every statement is dishonest), most central bankers score very low compared to almost every other profession. However, there is an optimal level of dishonesty as far as central bank policy is concerned, because the person who always lies is quickly disbelieved, which is why the value -100% cannot be optimal. Central banks will therefore occasionally communicate honestly and (even more rarely) actually do something about a rise in inflation (so that confidence returns and inflation expectations fall).

So that the central banks’ “game” cannot be seen through so easily, they will actually stimulate somewhat less strongly, raise interest rates and slow down the expansion of their balance sheets in order to give the impression that they are actually interested in lower inflation rates. In reality, they just want to push inflation expectations down, not realized inflation rates.

 

Why is that?

Politicians want to give election gifts, spend money. Central bankers are appointed by politicians. Sometimes the truth is rather flat and primitive. There were of course a few exceptions, e.g. Paul Volcker who successfully fought inflation in the 70s of the previous century, probably also the SNB, the Buba and some other central banks.

 

Of course, there are still some honest central bankers today

We are in the year 2021. All departments of all central banks are occupied by Romans… All departments of all central banks? No! Some departments populated by indomitable Gauls will not stop resisting the money multipliers. Unfortunately, life is easy for the central bank legionaries who, in the fortified camps of “FED, ECB, BOJ and BOE”, steal their well-deserved interest from honest savers and feed it to the over-indebted states. Too bad, the indomitable Gauls do not have a super drink.

 

Back to mismatch unemployment

Is mismatch unemployment really that high and why has it only risen so sharply in recent quarters? Presumably, the “true mismatch unemployment” is lower than Chart 1 makes it appear. Why? The large unemployment benefit payments in the U.S. provide a large incentive, especially among lower wage earners, not to work but to register as looking for work. If these special payments expire at the end of August, it should be possible to fill more vacancies again. Therefore, the statistics are likely to overestimate structural unemployment at present. Some of the job openings are not currently being filled because those registered as looking for work would rather receive the benefit payments than work, or perhaps are afraid of contracting Covid-19 while working.  For experts, with the expiration of support payments, the wage-Phillips curve should shift back down, the trade-off between employment and inflation should improve somewhat.  If the virus were defeated, this trade-off would improve further.

The following unanswered questions remain:

Who are the Gauls? Who are Asterix, Obelix, Getafix and how could you support them? What ingredients does the super drink contain, what is the recipe and (when) does the Roman Empire collapse?

Finding this out and telling the author is up to the reader!

 

Thomas Härter
Chief Investment Officer Aquila

 

 

 

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