Wednesday, January 28, 2009

Why unemployment lags 

Paul Krugman is making the case for the stimulus package based on the lag in unemployment -- it typically begins to fall well after the trough in the business cycle (as determined by NBER on the basis of series other than unemployment.) But one of those items NBER uses is the level of payroll employment.

The reason for this was explained years ago by Victor Zarnowitz. If you simply plot a sine wave and think of the wave as happening over time, you will see that from the bottom of the cycle you get a slow increase at first that quickens only after a bit. Employment grows from the trough, but Zarnowitz notes that at first it grows slower than the growth in the labor force (perhaps enhanced by discouraged workers re-entering the labor market.) Since UR = 1-E/LF, employment (E) has to grow faster than labor force (LF) for the unemployment rate UR to fall.

I fail to see how that becomes an excuse to have later stimulus. That shape of the growth of employment is simply a result of time-to-build issues: Just as there are lags in implementation of stimulus bills, there are also lags in the process of adding workers to the production process (hiring and training are not instantaneous -- these, btw, are part of the new Keynesian paradigm that Krugman embraces.) They do not avoid the types of concerns about the lateness of fiscal policy implementation envisioned by Friedman almost half a century ago. All that is old...