Geo-Graphics

The August “jobs report is an important reminder that all this tapering talk is insane and dangerous,” pronounced Slate economics writer Matt Yglesias, reflecting the consensus of the econo-commentariat.  But as today’s Geo-Graphic shows, the report is actually wholly consistent with a September Fed taper. “If the incoming data are broadly consistent with [the Fed’s economic] forecast,” Fed Chairman Ben Bernanke said in June, “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” This was widely interpreted in the markets to mean a September taper, which jibes squarely with subsequent FOMC member comments (and Bernanke’s unwillingness to suggest that it didn’t). The August jobs numbers were slightly weaker than the market consensus expectation, but the fall in the unemployment rate to 7.3% was one the Fed had in June not actually expected to see until the fourth quarter, as our figure on the left shows.  There was therefore no surprising negative news for the Fed in the unemployment numbers. But is the unemployment rate the right number to be looking at?  “With the [labor force] participation rate still falling,” Reuters’ Felix Salmon pointed out, “the unemployment rate is less relevant than ever.” Indeed, the participation rate—the percentage of the population in the labor force—fell in August to 63.2%, its lowest level in 35 years.  As our figure on the upper right shows, however, this decline is wholly on trend with the fall since 2001, and there is therefore no news for the Fed here either—the participation rate is precisely where the Fed should have expected it to be. (The flattening out between 2003 and 2007 was driven by abnormally robust labor demand.  An aging population is over time consistent with a declining participation rate.  See our post from May 21 of last year.) Importantly, as the bottom right figure shows, the decline in the participation rate was also not driven by a rise in discouraged workers—that is, the number of people who would like to work but have given up because of poor job prospects. The bottom line is that if an imminent Fed taper is misguided, as Yglesias, Salmon, and others have argued, it is not misguided because of the August jobs report.  The Fed could not have gleaned anything more negative in it than they would have expected back in June. CBO: Labor Force Projections Through 2021 Bloomberg: Unemployment Falling for Wrong Reason Creates Fed Predicament Kahn: Our Long-Term Unemployment Challenge (In Charts) Wonkblog: Three Reasons the U.S. Labor Force Keeps Shrinking   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

The German federal elections on September 22 could be of enormous consequence for Greek solvency – and the future of the eurozone.  Today’s Geo-Graphic shows that Greek solvency may itself be of great consequence to the German elections. As the figure shows, when the yield spread between German and Greek government bonds falls (and market optimism for Greek solvency rises), support for the small right-of-center, free-market German FDP party rises.  (The FDP is currently part of the Merkel-headed, CDU-led government.)   When that spread rises, however, support for the FDP falls, while support for the left-of-center SPD party rises.  (Support for Merkel’s CDU is invariant to shifts in Greek sentiment.) The International Monetary Fund has been making waves of late, not least in Germany, by casting doubt on Greece’s solvency – most recently, projecting a financing gap for Greece opening up in August of next year.  IMF rules forbid Fund lending to countries with projected financing gaps over the coming twelve months. Yields on 10-year Greek government bonds are up about 50 basis points over the past month. Market optimism or pessimism on Greece over the next two weeks could have a material impact on the German election outcome.  Greco-pessimism could dampen FDP prospects, possibly pushing them out of the Bundestag entirely.  The result would be months of uncertainty – as in 2005, when it took two months for a “grand coalition” CDU/CSU/SPD government to be put into place.  Another round of elections is a possibility.  In any case, it will be very hard to get a coherent German response to Greece – not to mention important wider eurozone issues, such as banking union – for some time.  Such a prospect could result in further spiking of Greek yield spreads, reviving the eurozone crisis at a time when the eurozone will be least able to deal with it. Au weh! Der Spiegel: Merkel’s Conservatives Split on Greek Aid Economist: Build Your Own Bundestag Financial Times: Germans Hostile to Further Transfer of Funds to Eurozone, Says Poll Wall Street Journal: Victory for German Opposition Looks Difficult Ahead of Election   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

The Bank of England’s dramatic new “forward guidance” policy, announced on August 7 with great fanfare, struck the markets like a soggy noodle – the FTSE fell, gilts fell, and sterling rose, none of which could the Bank have wanted to see. Why the disappointment?  Others have pointed to the multiple caveats and exit clauses, but we would highlight something much more tangible: the pledge to keep interest rates super-low at least until unemployment fell to 7% was meaningless, as 7% is nearly two full percentage points over what the Bank considers to be the long-term equilibrium rate of UK unemployment.  This is like a football coach pledging to keep throwing the football until his team is down by less than 50 points; it tells the defense nothing it didn’t already know. Compare the BoE’s rate pledge to the Fed’s rate pledge, which has the latter committing to a near-zero policy rate until unemployment falls to less than a percentage point above what the Fed considers to be the long-term equilibrium rate of US unemployment.  While hardly shocking, the Fed’s commitment was newsworthy. If a 7% unemployment target was the best that new BoE Governor Mark Carney could deliver through his Monetary Policy Committee, he would have been better advised to skip the forward guidance and simply let the market judge his actions going forward. Bank of England: August Inflation Report The Guardian: MPC Member Failed to Back Carney Over Forward Guidance The Economist: Guidance on Forward Guidance Financial Times: Carney Ties UK Rates to Jobs Data   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics