Evan Soltas
Jun 1, 2012

The Fed's Job Well Done

The May jobs report is out from the Bureau of Labor Statistics, and it is ugly. 69,000 in May and a 50,000-job downward revision of the April numbers. Let's look at why this jobs slowdown is happening.

This is the only explanation which to me makes any sense, and it's made up of three related parts.

(1) Growth in nominal GDP has slowed.
(2) Short run nominal GDP expectations have dropped.
(3) Uncertainty as to future growth and levels of nominal GDP has increased.

Alternatively, one could phrase the causation as a fall in aggregate demand combined with a drop in AD expectations and an increase in the uncertainty attached to those expectations. Together, they add up to the recipe for a nominal slowdown, that is, one of the Fed's making. Now there very well may be other factors, such as the European distress, pushing (1), (2), and/or (3) -- but that doesn't obviate the Fed of its responsibility to counteract, to engage in stabilization policy.

The graph above, which shows the annualized monthly percent change in BLS' nonfarm payroll numbers against the annualized quarterly percent change in NGDP lagged by one quarter, makes point (1) obvious. After NGDP growth sagged in the first quarter of 2011, bottoming out at 3.1 percent, and payroll growth nearly went to zero in August 2011, the Fed intervened, suggesting some degree of commitment, and something resembling nominal stability and the sort of real growth the United States should be having after such a recession returned. Since then, it's clear the Fed has sat on its hands. NGDP growth has already slowed by roughly a percentage point since the end of 2011 -- we got new numbers yesterday in the Bureau of Economic Analysis report.

However the NGDP decline thus far understates its influence. The big change, I worry, has been in NGDP expectations, discussed in point (2). As I've documented recently on this blog, inflation expectations have dropped dramatically since earlier this winter. What I've just realized is that the inflation expectations have continued to fall. We now stand at a one-year breakeven of 0.37, a 38 percent drop just on the day. That is not a misprint. What this means is that NGDP expectations too have fallen, given that the change in inflation is demand-driven.

Onwards to point (3), which says that uncertainty is rising and compounding the problems of falling present and future NGDP. When I talk about uncertainty, what I mean is that individuals' probability distributions of where NGDP and NGDP growth will be in the short run have seen the level of dispersion increase significantly. Increased NGDP uncertainty or aggregate demand uncertainty is a strong, underlying factor pulling down NGDP growth in (1) and expectations in (2) -- as it delays commitments from firms like hiring or investment and reduces consumer confidence. The uncertainty could very well be coming from trouble in the Eurozone, but if it wanted to, the Fed would be no less able to determine NGDP expectations in such an environment. (See my posts here and here about Switzerland's central bank to understand just how powerful credible promises can be as a expectations-based channel for monetary policy.)

So that's how to read May's job report. This is what happens when you reduce NGDP growth and NGDP expectations and increase uncertainty in the context of already weak aggregate demand.