Bernanke Channeling Hatzius Dismissing Gross New Normal

He made that diagnosis last week in a rebuttal to those who blame an 8.3 percentunemployment rate on structural shifts in the economy wrought by the financial crisis and who contend joblessness is permanently elevated.

 “I see little evidence of substantial structural change in recent years,” Bernanke told fellow central bankers and economists at the annual monetary-policy symposium in Jackson Hole, Wyoming. “Following every previous U.S. recession since World War II, the unemployment rate has returned close to its pre-recession level.”

The message for investors is Bernanke believes what he calls the “grave concern” of 12.8 million Americans out of work can be tackled by a stronger economic recovery, driven by monetary support if necessary. The view that the country’s woes are cyclical was a keen subject of debate in the shadow of the Teton mountains, dividing Bernanke’s fellow central bankers, Wall Street economists and academics.

Backing Bernanke are Princeton University’s Alan Blinder, Jan Hatzius of Goldman Sachs Group Inc. and Stanford University’s Edward Lazear. On the other side are Richmond Fed PresidentJeffrey Lacker, Northwestern University’s Robert Gordon and Mohamed El-Erian and Bill Gross of Pacific Investment Management Co., who popularized the term “new normal” to describe how growth patterns changed after the worst recession since the Great Depression.

Tight Credit

Bernanke and his supporters argue that the sluggish recovery and lingering unemployment are more the result of temporary headwinds, such as tight credit conditions and housing-market weakness, and can be cured with monetary aid. His critics blame structural changes, such as a mismatch between job openings and skills. They say further easing will help little and may even do harm by fanning inflation.

“In an environment where the actual unemployment rate is not coming down, at least not quickly, I think there’s still room for monetary policy to do more,” said Goldman Sachs Chief Economist Hatzius, whose estimate of the so-called natural rate of unemployment that triggers inflation is just below the 6 percent calculation of Fed researchers. “My view of this is pretty similar to the Fed’s.”

At Pimco, co-Chief Investment Officers El-Erian and Gross estimate the natural rate is closer to 7 percent.

“Our analysis strikes a different balance between cyclical and structural factors,” Newport Beach, California-based El- Erian said in an e-mail after Bernanke’s Aug. 31 speech. “It places greater emphasis on structural headwinds, including segments of the labor, housing and credit markets.”

Asset Purchases

Those headwinds can be affected “only at the margin” by quantitative easing, or large-scale asset purchases, Gross said in a separate e-mail.

“That is why after three-plus years of zero-based interest rates and $2 trillion of the Fed’s balance-sheet expansion, the economy is only growing at 2 percent,” he said. “Cyclical weakness is more easily rectified with quantitative easing remedies than structural weaknesses, which rest more logically in the hands of fiscal policy makers.”

Just what is ailing the U.S. economy formed part of Bernanke’s case for greater Fed intervention that may come as soon as the next meeting of policy makers on Sept. 12-13. The 58-year-old former Princeton University economist and Great Depression scholar used his Jackson Hole address to lament the suffering caused by unemployment, and his defense of unorthodox policies such as bond-buying signaled he may deploy them again.

Costs of Policies

“The costs of non-traditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant,” Bernanke said. “Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market.”

Bernanke’s challenge may be highlighted Sept. 7, when economists surveyed by Bloomberg News predict Labor Department data will show unemployment exceeded 8 percent for a 43rd straight month in August as payrolls grew by 125,000, slowing from July’s 163,000 gain.

At the same time as some of his colleagues question his faith in monetary policy’s power, they also push back against his labor-market analysis. St. Louis Fed President James Bullard told the conference “it sure looks like the economy was on one trend pre-crisis and is on a very different trend post-crisis.”

“It’s quite unhelpful to equate structural and permanent factors,” the Richmond Fed’s Lacker said during the same discussion. The gap will eventually close as “people are working on training programs” to address the mismatch in skills.

‘Real Impediments’

“In the meantime these are real costs, real impediments to clearing labor markets the way we want, and it’s not clear monetary policy can obviate these costs,” said Lacker, who dissented from the Federal Open Market Committee’s Aug. 1 statement, which repeated the benchmark lending rate is likely to stay close to zero at least through late 2014.

The debate over just how transitory high unemployment will be is also sparking academic scrutiny. In Wyoming, Bernanke received backing from a study by Stanford’s Lazear and James Spletzer of the U.S. Census Bureau.

It concluded that weak economic growth is the reason for heightened joblessness rather than fundamental labor-market weaknesses. Unemployment stems mostly from “cyclic phenomena” that are more pronounced after the last recession than after prior contractions, the authors wrote.

Construction, Retailing

They cited data showing that industries such as construction, manufacturing and retailing that had the biggest losses during the recession have also gained the most jobs since the recovery began. The 18-month slump that ended in June 2009 was the longest since the Great Depression.

“The problem is not the structure of the labor market, but the weakness of the economy,” Lazear said in an interview. “If the economy was stronger, the labor market would be stronger.”

A study published last month by economists at the Federal Reserve Bank of New York echoed his findings. It estimated only about one-third of the jump in unemployment from 5 percent to its 10 percent peak in October 2009 can be traced to a divergence between the supply of labor and job openings. The remainder was due mainly to a lack of demand, it suggested.

Potential Growth

Not all economists agree. A paper written by Northwestern’s Gordon, published last week by the National Bureau of Economic Research, concludes the potential growth rate in the U.S. is damaged, and the past 250 years may prove to have been a “unique” period of expansion.

Ben Bernanke should read my paper,” said Gordon, a member of the NBER committee that determines when recessions begin and end.

Dean Maki, chief U.S. economist at Barclays Plc in New York, is another skeptic. His work suggests a shift in the so-called Beveridge Curve, which measures the relationship between job openings and unemployment and indicates there are more jobs available today than before the recession given the current unemployment rate.

That suggests to him the natural rate is about 7 percent, and while “it doesn’t mean the Fed can’t reduce unemployment, it does mean we’re likely to see inflation pressures emerge sooner.”

More Dangerous

One area of agreement: the longer unemployment stays high, the more dangerous it is for the economy. Princeton’s Blinder and Deputy Bank of England Governor Charles Bean cited Europe’s experience in the 1980s of so-called hysteresis, when the failure to find jobs led to workers losing skills and becoming unemployable.

“We may get structural shifts like Europe in the 1980s,” said Blinder, a former Fed vice chairman. Bean warned “cyclical unemployment can turn into structural unemployment,” especially if the long-term jobless suffer “disenfranchisement.”

“You shouldn’t assume that they will just naturally get sucked back in,” Bean said.

“We would agree with Chairman Bernanke that the longer the economic malaise persists, the greater the risk that it will get embedded in the structure of the economy,” Pimco’s El-Erian said. “It is a loud call for policy action, and one that needs to involve many more official entities than just the Fed.”


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