About this time last year, people were asking: How low will the unemployment rate go? Now, after shrinking to a three-decade low of 3.9% in September, 2000, the jobless rate's half-point surge last month, to 5.4%, in the wake of the September 11 terrorist attacks is provoking just the opposite question: How high will it go?
The consensus view is that unemployment will peak at about 6% by around the middle of next year, assuming the recession is a relatively mild one. However, some economists are beginning to think a 6% peak rate might be too optimistic, even in a mild downturn. Worse still, once the unemployment rate peaks, it is likely to remain at that level for most, if not all, of 2002.
To be sure, movements in the jobless rate lag behind changes in economic activity and so are somewhat backward-looking. But unemployment news greatly affects consumer confidence and attitudes toward spending. A rise in the jobless rate to 6% would put nearly 1 million more people out of work on top of the 2.2 million newly unemployed in just the past year. Every increase of a tenth of a percentage point above 6% would add about another 140,000 to the jobless rolls.
The Federal Reserve wants to cap that rise. On Nov. 6, the Fed went for a half-point cut in interest rates, instead of a quarter-point, citing "heightened uncertainty and a deterioration in business conditions both here and abroad." The Fed dropped the overnight federal funds rate to a 40-year low of 2% and the discount rate to 1.5%, and its statement left the door wide open for further moves. However, policymakers are likely to go back to quarter-point cuts from now on, given that reductions this year now total a huge 4.5 points.
MORE CUTS WILL PROBABLY BE NEEDED to turn around the economy and the labor markets. The Labor Dept.'s jobs data show that the unemployment rate has jumped nearly a full percentage point in only four months, and monthly payrolls plunged 415,000 in October. Private payrolls have been shrinking since last March (chart), indicating only part of the October layoffs were related to the September 11 attacks.
Other data point to a sharp deterioration in job prospects. Help-wanted advertising in September newspapers hit an 18-year low, and the weekly level of new claims for jobless benefits is consistent with monthly payroll losses in the 200,000 to 250,000 range. Some of the labor-market weakness reflects the initial shock of the September 11 events. But two months later, claims show no sign of drifting lower as yet.
Of course, rising jobless claims are typical in a recession, but a top worry in the outlook is how next year's economic performance will play out in the labor markets. Mild recessions usually generate moderate recoveries. So even though real gross domestic product is expected to rise next year, it may not grow fast enough to lift payrolls quickly.
More important, one key downside of the New Economy is that a high-productivity economy requires strong growth in order to utilize fully all available labor and machines. The U.S. appears able to maintain a growth rate of 3% or more without worrying about rising inflation. That also means the U.S. must grow at least 3% just to keep the unemployment rate stable. And it will have to grow considerably quicker than that pace in order to bring the jobless rate down.
PRODUCTIVITY HAS HELD UP remarkably well in this recession. Despite the third-quarter drop in real GDP, output per hour last quarter rose at a sturdy 2.7% annual rate from the second quarter. During the past year, productivity has grown 1.9%, even though real GDP increased only 0.8% (chart). Companies responded to weaker demand by cutting back hours and jobs, leading to the increase in the jobless rate.
Moreover, productivity may well rise again in the fourth quarter. Hours worked began this quarter nearly 4% below their third-quarter average, measured at an annual rate of decline, about a percentage point faster than they fell in the third quarter. If, for example, real GDP contracts 2% this quarter--as many economists expect--then productivity would grow 2%.
By the end of this year, the economy's yearly growth rate will have slowed from more than 5% to less than zero, a swing of some 5.5 percentage points. But the pace of productivity will likely have slipped by only half that much. In the past, an economic slowdown of the same magnitude would have generated a much sharper drop-off in productivity growth. And productivity is set to pick up as the economy recovers.
This strongly suggests that, although some of the late 1990s productivity surge was transitory, the economy is also retaining some of the gains. The Fed noted in its Nov. 6 rate statement that, while the shift in resources to enhance security after September 11 may restrain productivity advances for a while, "the long-term prospects for productivity growth and the economy remain favorable," and they will reassert themselves.
THE PROBLEM FOR NEXT YEAR is that businesses desperate to rebuild their profit margins will concentrate on lifting productivity gains rather than hiring new workers. The same thing happened after the 1990-91 recession, in the so-called jobless recovery. The unemployment rate rose a full percentage point during the year following the end of the recession.
Cost-cutting efforts by businesses are starting to show up in the form of shorter hours, less overtime, and slower wage growth. In October, the workweek shrank almost a half-hour from a year earlier (chart). Factory overtime hit a nine-year low. Hourly pay for production workers barely rose from September. All those cutbacks mean slower income growth, a downtrend that will continue in coming months as the upper hand in the labor markets shifts back to companies and away from workers.
One plus from slack labor demand will be lower inflation next year. Add in cheaper energy and falling nonenergy import prices, and 2002 could mark the first year of outright price stability since the 1960s. That will boost household buying power and give the Fed considerable room to nudge interest rates even lower.
Low inflation also explains much of the recent rally in the bond market. Clearly, some of the favorable reaction in long-dated Treasuries outside of the 30-year bond was overdone, a reaction to the government's elimination of its 30-year offering. But this year's drop in long-term rates is based on the sound fundamental of falling inflation expectations.
Of course, increased buying power due to lower rates and inflation won't do consumers much good if they don't have a job or if they are worried about losing the one they have. This will be the first New Economy recession, and while productivity growth is likely to hold up surprisingly well, those gains may well come at a heavy cost to workers.
By James C. Cooper & Kathleen Madigan
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Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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