Constitutes Sound Fiscal Policy
Henry C.K. Liu
This article was rejected by the editor of New Deal 2.0 for being too
for the general public.
It was pulbished in AToL
on August 12, 2010
There is an undisputed general law in public finance that
sound fiscal policies must precede a sound currency. What is in dispute
constitutes a sound fiscal policy. Neoliberals deem recurring fiscal
as signs of unsound fiscal policy. Yet over the multi-year duration of
recession phases of business cycles in market economies, multi-year
financing to stimulate economic activities in a recession can be a very
Under such circumstances, a balanced annual budget would be
quite the opposite of a sound fiscal policy. Still, some recessions may
more than a decade to recover even with persistent fiscal deficits if
are spent on wrong targets, as in the case of Japan
after the Plaza Accord of 1985.
The Situation in
In Japan after Plaza Accord, the fiscal deficit did not help the
Japanese economy because it had been
spent on the wrong targets.
Realistically, reducing the debt/GDP ratio is difficult with only
fiscal reform: the economy must also be on a growth path.
As the fiscal deficit widens, the Bank of Japan bought up larger
amounts of government bonds to avoid disruption in the
government bond market. In this sense, Japan today resembles post-World
II United States where the Federal Reserve implemented a bond price
support policy to keep interest rates low.
Moreover, just as the
exchange rate of the dollar was not damaged by Federal Reserve policy
of bond support to keep interest rate low, the bond-buying trend
in Japan has not lowered market confidence in the yen. Similar to the
US in that
period, Japan is a creditor that enjoys a persistent current account
surplus. Thus Japan has the strength to ward off market challenges to
confidence in its
currency despite the mounting government debt financed by
the central bank.
US policy after
World War II was to buy government bonds by quantitative easing to
rise in public debt, and to leverage economic growth for a soft-landing
ratio. Japan today is similar in that the Bank of Japan is buying a
limited amount of government bonds, but differs in that it shows no
signs of halting growing debt and is falling into deflation and
Quantitative easing (QE) describes a central bank monetary policy to
increase the supply of money in an
economy when the bank interest rate, discount rate and/or interbank interest rate are either at, or
close to, zero. A central bank does this by first crediting its own
account with money it has created ex nihilo (out of nothing).
It then purchases financial assets, including government bonds and
corporate bonds, from banks and other financial institutions in a
process referred to as open market operations.
The purchases, by way of account deposits, give banks the excess
reserves required for them to create new money by the process of
from increased lending in the fractional reserve banking system. The
increase in the money supply thus stimulates the economy. Risks include
overeasing, spurring hyperinflation,
or the risk of not being effective enough, if banks opt simply to
pocket the additional cash in order to increase their capital reserves
in a climate of increasing defaults in their present loan portfolio.
The latter seems to be what has happened in 2009 in US banks.
England shows that fiscal deficits can be cut even under deflation. In
England’s case, however, improved productivity after the industrial
revolution and the subsequent population increase generated high growth
that more than offset deflation and helped lower the debt ratio. Japan,
however, suffers not only low growth but also population decline;
reducing the debt/GDP ratio under deflation seems unrealistic. The US
economy will face population growth problems if current
anti-immigration sentiments continue. Coupled with slow growth,
the US economy will face many of the same problems faced by Japan
in her lost decade.
Like the US, Japanese citizens share a sense of urgency regarding
Japan’s fiscal health. In a public opinion poll, 60% of respondents
already think that “raising consumption tax is unavoidable to maintain
the social security system” (“Yomiuri Shimbun”, November 2009 survey).
Behind such opinion is the heightened sense of crisis concerning
Japan’s deteriorating fiscal health following the Lehman bankruptcy
stronger understanding that new financial resources are necessary to
improve child-rearing support and impoverished healthcare; and the
reality that even “budget screening” will only produce marginal
revenue. Recent media coverage juxtaposing Greece’s crisis with Japan’s
fiscal situation may also be contributing to public awareness. Yet the
US, unlike Japan, does not enjoy a trade surplus to tap the consumption
of other economies to cushion a reduction of its own fiscal deficits
Japan’s 2009 government
debt ratio is on par with post-Napoleonic War England (accumulative
long-term debt reached 171%,
of GDP). The government bond market survives
because almost all of the bonds are denominated in yen and held
domestically (about 95%), and
there is significant political room to raise taxes in the future.
25.1% tax burden ratio (fiscal 2008) is low compared to European
countries (England 37.5%; France 37.6%; Sweden 51.5%), and the
possibility of a consumption tax hike is particularly
high. If citizens recognize that their tax burden is low and accept a
higher consumption tax there is no reason why the government bond
market should collapse from worries over bond redemption. As society
ages and the savings rate falls, however, Japan does face a gradual
decline in its capacity to absorb government bonds.
Of course, to reduce the
debt ratio Japan must not only raise taxes but also shake free from
deflation and embark on an economic growth track (high nominal growth
that yields a degree of inflation). Japan is fortunate to be in
proximity of rapidly growing emerging markets such as China, affording
it great potential to maintain growth by maximizing such demand.
Whether Japan can really leverage this demand is unclear, but the
potential leaves the door open to fiscal reform.
While Japan’s fiscal
situation is therefore severe, there are paths towards improvement such
as tax raises and growth. The issue is whether there is the political
will to stanch further fiscal deterioration and make tax hikes and
growth a reality. Absent a show of government will in this direction,
the market will focus only on the negatives such as a falling capacity
to absorb government bonds and difficulties in spurring growth and
raising taxes. Japan will be expected to become a deficit country even
if it enjoys a current account surplus at that point. Of the forces
that pressure the government towards fiscal prudence, market pressure
such as rising long-term interest rates should come into play.
Moderate pressure from
the market notwithstanding, Japan will likely end up raising taxes and
addressing the problems without inviting disturbance in the market. The
Bank of Japan will then need to provide financial support to foster an
environment favorable to realizing high growth.
The Situation In the
In March 2005, the EU’s Economic and Financial Affairs
Council (ECOFIN), under the
pressure of France
relaxed the rules to respond to criticisms of insufficient flexibility
make the pact more enforceable. Permissiveness infested the theoretical
regulatory framework at the boom phase of the business cycle.
At the urging of Germany
ECOFIN agreed on a reform of the Stability and Growth Pact
euro convergence criteria as spelled out in the SGP are:
1. Inflation rates:
No more than 1.5
higher than the average of the three best performing (lowest inflation)
states of the EU.
government fiscal deficit:
The ratio of the
fiscal deficit to GDP must not exceed 3% at the end of the preceding
year. If not, it is at least required to reach a level close to 3%.
exceptional and temporary excesses would be granted for exceptional
The ratio of gross
debt to GDP must not exceed 60% at the end of the preceding fiscal
if the target cannot be achieved due to specific conditions, the
have sufficiently diminished and must be approaching the reference
value at a
3. Exchange rate:
joined the exchange-rate mechanism (ERM II) under the European Monetary
(EMS) for two consecutive years and should not have devaluated its
during the period.
The nominal long-term
must not be more than 2 percentage points higher than in the three
The ceilings of 3% of GDP for budget
and 60% of GDP for public debt were maintained, but the decision to
in excessive deficit can now rely on certain parameters: the behavior
cyclically adjusted budget, the level of debt, the duration of the slow
period and the possibility that the deficit is related to
productivity-enhancing procedures. The pact is part of a set of Council
Regulations, decided upon at the European Council Summit on March 22-23, 2005. Having
adopted unneeded permissiveness at the boom cycle, Germany is now
leading the charge to reduce fiscal deficits in eurozone by
promoting austerity programs in every eurozone member state in the
midst of a severe recession.
The Curse of IMF
The problem with the IMF “conditionalities” cure in a
sovereign debt crisis is its insistence on a balanced fiscal budget at
time – during a monetary-induced recession, thus adding to the economic
unnecessarily and assigning disproportional burden on the most
segment of the population – the working poor, and condemning the
economy to an unnecessarily long path toward recovery. See full article
The Issue of Fiscal
Some are concerned
that long-term Federal debt may balloon up to
180% of GDP.
While this development should be arrested by
fiscal prudence, that is perhaps only half of the solution. The other
half is to direct the fiscal deficit toward GDP growth.
Sometimes a large fiscal deficit can help actually reduce its share of
the GDP if the fiscal deficit generates a bigger GDP.
The Federal fiscal deficit in 1919 was 16.8% of a GDP of
$78.3 billion.The war time Federal
deficit in 1945 was 24.1% of a GDP of $223 billion. Despite a high
deficit, US GDP kept rising after the WWII to $275.2 billion in 1948
fiscal surplus equaling 4.3% of GDP. The 2010 Federal deficit is
projected to be
10.6% of a GDP of $14.6 trillion.
Between 1920 and 1929, the Federal budget had a small
surplus, while the GDP grew to $103.6 billion in 1929. After the 1929
the 1930 GDP fell $12.4 billion, about 12%, to $91.2 billion, while the
budget under Hoover still
surplus of 1% of GDP.
Not until Franklin D Roosevelt came into office in 1933 when
the GDP had fallen by almost half to $56.4 billion that the Federal
jump to 3.27% of GDP in 1934. All through the New Deal years, the
deficit stayed below 5% with the average annual deficit at around 3% of
did not rise until after the US
entered WWII and peaked at 28.1% in 1943, 22.4% in 1944 and 24.1% in
falling to 9.1% in 1946 when the GDP was $222.2 billion.
The total Federal fiscal deficit for the four years of WWII
was about 100% of the average annual GDP of the same period. At the
be the strongest economy of the world because the fiscal deficit was
finance war production, not to bail out distressed financial
institutions and inefficient
fiscal deficit for FY2009 was more than $1.75 trillion -- about 12.3%
the biggest since 1945. According the White House Budget Office, the
fiscal deficit between FY2009 and FY2019 is projected to be almost $7
trillion.Total gross Federal debt in
2008 was $10 trillion, projected to rise to over $23 trillion in 2019.
held by the public is projected to rise from $5.8 trillion in 2008 to
trillion in 2019. Interest expense in 2008 was $383 billion. Projection
expected to rise as both debt principal and interest rate are expected
The Issue of
Inflation is a different story. Moderate inflation is
necessary for optimum economic growth, provided the burden of inflation
equally shared by all segments of the population, particularly not
merely on wage
the end of World War I, in 1919, US prices were rising at the rate of
annually, but the economy roared ahead as wages were rising in tandem
slightly ahead of prices through wage-price control.
Income policies involving wage-price control were employed
throughout history from ancient Egypt,
under Hammurabi, ancient Greece,
during the American and French revolutions, the Civil War, World War I
A case can be made that that wage-price control has a mixed record as a
restrain inflation, but it is irrefutable that income policies are
balancing supply and demand.
Yet in response to inflation, the Federal Reserve Board
raised the discount rate in quick succession in 1919, from 4% to 7%,
it there for 18 months to try to rein in inflation by making money more
expensive when banks borrowed from the Fed. The result was that in
The current financial crisis started in late-2007 and
stabilized around mid-2009 after direct massive Fed intervention. It
many measures an unprecedented phase in the history of the US
banking system. In addition to the systemic stress and the stress faced
largest investment and commercial banks, 168 depository institutions
from 2007 through 2009.This was not the
largest number of bank failure in one crisis. At the height of the
loan (S&L) crisis from 1987 to 1993, 1,858 banks and thrifts
However, the dollar value of failed banks assets in the financial
2007-2009 was $540 billion, roughly 1.5 times of the bank assets that
the S&L crisis in 1987-1993.
A research paper funded by the Federal Deposit Insurance
Corporation (FDIC) on Bank Failures and
the Cost of Systemic Risk: Evidence from 1900-1930, by Paul Kupiec
Ramireza (July 2008) found that bank failures reduce subsequent
growth. Over this period, a 0.12 percent (1 standard deviation)
increase in the
liabilities of the failed depository institutions results in a
reduction of 17
percentage points in the growth rate of industrial production and a 4
point decline in real Gross National Product (GNP) growth. The
within three quarters of the initial bank failure shock and can be
as a measure of the costs of systemic risk in the banking sector. The
been created by the New Deal only after 1934 to protect depositors.
In the current crisis that began in mid-2007, with the
discount rate falling steadily to 0.5% on December 16, 2008 from a high
6.25% set on June 2006, still 25 banks failed in 2008 and were taken
the FDIC while 140 banks failed in 2009 and 33 banks failed in just the
two months of 2010, putting the fee-financed FDIC in financial stress.
Fed raised the discount rate to 0.75% on February 19, 2010. In contrast, in the five
to 2008, only 11 banks had failed from the debt bubble even when the
rate stayed within a range from 2% to 6.25%.
Volcker, the Fearless
Slayer of the Inflation Dragon
In the 1980s, to counter stagflation in the US
economy, the Fed under Paul Volcker, (August 6, 1979 – August
1987), fearless slayer of the inflation dragon, kept discount rate in
double digit range from July
to August 27 1982,
at 14% on May 4, 1981.
August 1982 to its peak in August 1987, the Dow Jones Industrial
grew from 776 to 2722. The rise in market indices for the 19 largest
the world averaged 296 percent during this period.
Volcker, as chairman of the Fed before Greenspan, caused a
“double-dip” recession in 1979-80 and 1981-82 to cure double-digit
in the process bringing the unemployment rate into double digits for
time since 1940. Volcker then piloted the economy through its slow long
recovery that ended with the 1987 crash. To his credit, Volcker did
bring unemployment below 5.5%, half a point lower than during the
and the acknowledged structural unemployment rate of 6%.
Two months after Volcker left the Fed, to be succeeded by
Alan Greenspan, the high interest rate left by Volcker, inter alia, led
to Black Monday, October 19, 1987, when
stock markets around the world crashed mercilessly, beginning in Hong
spreading west to Tokyo and Europe as markets opened across global time
hitting New York only after markets in other time zones had already
a significant margin. The DJIA dropped 22.61%, by 508 points, to
Black Monday 1987. On October 11, 2007, the DJIA
hit a high of 14198.10. On March 2, 2009, it lost
almost 300 points, or 4.2%, to end at 6763.29, its lowest point since April 25, 1997.
By the end of October, 1987, stock markets in Hong Kong
had fallen 45.8%, Australia
41.8%, New Zealand
the United Kingdom
26.4%, the United States
22.68%, and Canada
22.5%. Fundamental assumptions such as market fundamentalism, efficient
hypothesis and market equilibrium were challenged by events. Despite
dismal record in the 1980s, Volcker was appointed by President Obama
decades later as first Chair of the President's Economic Recovery
Board on February 6, 2009.
The 1987 stock-market crash was unleashed by the sudden
collapse of the safety dam of portfolio insurance, a hedging strategy
possible by the new option pricing theory advanced by Nobel laureates
Merton and Myron S Scholes. Institutional investors found it possible
risk better by protecting their portfolios from unexpected losses with
positions in stock-index futures. Any fall in stock prices could be
by selling futures bought when stock prices were higher.
This strategy, while operative for each individual portfolio, actually
the entire market to collapse from the dynamics of automatic
futures. Investors could afford to take greater risks in rising markets
portfolio insurance offered a disciplined way of avoiding risk in
albeit only individually. But the reduction in individual risk was
an increase in systemic risk.
As some portfolio insurers sold and market prices fell
precipitously, the computer programs of other insurers then triggered
sales, causing further declines that in turn caused the first group of
to sell even more shares and so on, in a high-speed downward spiral.
turn electronically generated other computer driven sell orders from
sources, and the market experienced a computer-generated meltdown at
The Unlearned Lesson
of the 1987 Crash
The 1987 crash provided clear empirical evidence of the structural flaw
market fundamentalism, which is the belief that the optimum common
only achievable through a market equilibrium created by the effect of
individual decisions of all market participants each seeking to
own private gain through the efficient market hypothesis, and that such
equilibrium should not be distorted by any collective measures in the
the common good or systemic stability.
Aggregate individual decisions and actions in unorganized unison can
do turn into systemic crises that are detrimental to the common good.
Unregulated free markets can quickly become failed markets. Markets do
simply grow naturally after a spring rain. Markets are artificial
designed collectively by key participants who agree to play by certain
All markets are planned with the aim of eliminating any characteristic
free for all operations. Free market is as much a fantasy as free love.
In response to the 1987 crash, the US Federal Reserve under its newly
chairman, Alan Greenspan, with merely nine weeks in the powerful
immediately flooded the banking system with new reserves, by having the
Market Committee (FOMC) buy massive quantities of government securities
the repo market. He announced the day after the crash that the Fed
as a source of liquidity to support the economic and financial system.”
Greenspan created $12 billion of new bank reserves by buying up
securities from the market, the proceeds from which would enter the
The $12 billion injection of "high-power money" in one day caused the
Fed funds rate to fall by 75 basis points and halted the financial
though it did not cure the financial problem, which caused the US
economy to plunge into a recession that persisted for five subsequent
Worst of all, the monetarist cure for systemic collapse put the
in a pattern of crisis every decade: the 1987 crash, the 1997 Asian
crisis and the financial crisis of 2007.
High-power money injected into the banking system enables banks to
bank money through multiple credit-recycling, lending repeatedly the
minus the amount of required bank reserves at each turn. At a 10%
requirement, $12 billion of new high-power money could generate in
theory up to
$120 billion of new bank money in the form of recycled bank loans from
deposits by borrowers.
The Brady Commission investigation of the 1987 crash showed that on October 19, 1987, portfolio
insurance trades in S&P 500 Index futures and New York Exchange
crashed the market amounted to only $6 billion by a few large traders,
out of a
market trading total of $42 billion. The Fed’s injection of $120
three times the market trading total and 20 times the trades executed
Yet post-mortem analyses of the 1987 crash suggest that though
strategies were designed to be interest-rate-neutral, the declining Fed
rate was actually causing financial firms that used these strategies
lose money from exchange-rate effects. The belated awareness of this
caused many institutions that had not understood the full dynamics of
strategies to shut down their previously highly profitable bond
The Rise of Hedge
This move later led to the migratory birth of new,
stand-alone hedge funds such as Long Term Capital Management (LTCM),
continued to apply similar highly leveraged strategies for spectacular
profit of more than 70% returns on equity that eventual led it to the
edge of insolvency
when Russia unexpectedly defaulted on its dollar bonds in the summer of
The Fed had to orchestrate a private-sector creditor bailout of LTCM to
systemic damage to the financial markets. The net effect was to extend
liquidity bubble further – causing it to migrate from a distressed
sector to a healthy
The 1987 crash reflected a stock-market bubble burst the liquidity cure
which led to a property bubble that, when it also burst, in turn caused
savings-and-loan (S&L) crisis.
While the 1987 crash was technically induced by program
trading, the falling dollar was also a major factor. Although the
started to decline in exchange value by late February, 1985 due to US
deficit, that decline had yet to reduce the US trade deficit, causing
protectionist sentiment in the US to mount as the trade deficit swelled
annual rate of $120 billion in the summer of 1985.
The Issue of Exchange
In part to deflect protectionist legislation, US officials
arranged a meeting of G-5 officials at the Plaza Hotel in New York on
22, 1985 with the purpose of ratifying an initiative to bring about an
decline in the dollar, observing that “recent shifts in fundamental
conditions among their countries, together with policy commitments for
future, have not been fully reflected in exchange markets,” and
“further orderly appreciation of the main non-dollar currencies against
dollar is desirable,” and that the G5 members “stand ready to cooperate
closely to encourage this.” During the seven weeks following the Plaza
G-5 authorities sold nearly $9 billion, of which the US
sold $3.3 billion for other currencies, while speculators profited by
The dollar had declined to seven-year lows in early 1987 amid signs of
in the US
economy while the US
trade deficit continued to grow. Demand was sustained not by income but
debt. Public statements by Reagan Administration officials were
exchange markets as indicating a lack of official concern about the
ramifications of further declines in the dollar.
On February 22, 1987,
officials of the G5 plus Canada
at the Louvre in Paris to
that the dollar had fallen enough. But despite heavy intervention
dollars following the Louvre Accord, the dollar continued to decline,
particularly against the yen. Market participants perceived delays in
implementation of expansionary fiscal measures in Japan
expected after the Louvre Accord and talks of trade sanctions on some
products heightened concern about tension in US-Japanese trade
Following the Louvre Accord, the G-7 authorities intervened heavily in
of the dollar throughout the episodes of dollar weakness in 1987, and
dollars on several occasions when the dollar strengthened
official dollar purchases by the G-7 and other major central banks
financed more than two-thirds of the $144 billion US current account
1987. The US
share of these purchases was $8.5 billion, and the share of the other
countries was $82 billion, since the non-dollar export-dependent
wanted desperately to halt the appreciation of their currencies.
Record US trade deficits and market perceptions that the G-7
pursuing monetary measures best suited to their own separate domestic
objectives soon sparked a further sell-off of the dollar. This
contributed to a
worldwide collapse of equity prices which had risen to levels
fundamentals. The dollar’s decline gathered new momentum when the
Reserve under its new chairman Alan Greenspan moved more aggressively
foreign counterparts to supply liquidity in the aftermath of the 1987
market crash which had been triggered by program trading on portfolio
derivatives arbitraging on macroeconomic instability in exchange rates
Accommodative Monetary Stance and Exchange Rates
The Federal Reserve’s actions under Greenspan in 1987 led
market participants to conclude that the Fed would emphasize domestic
with accommodative monetary stance, if necessary at the cost of a
decline in the dollar. By year-end, the dollar's value had fallen 21%
the yen and 14% against the mark from its levels at the time of the
Accord while Greenspan, the wizard of bubble-land, was on his way to
hailed as the greatest central banker in history. Two decades later, by
the Greenspan put was called by the market and trillions of dollars
The Issue of Unemployment
Half a century before 1987, beginning in 1921, deflation had
descended on the US
economy like a perfect storm from Fed tight monetary policy under
Daniel R. Grissinger, with farm commodity prices falling 50% from their
peak, throwing farmers into mass bankruptcies. Business activity fell
one-third; manufacturing output fell by 42%; unemployment rose fivefold
adding 4 million to the jobless count.
Since mid-2007, the US
has lost over 6 million jobs, with 4.4 million jobs lost in the first
the Obama administration. Latest government estimate puts the Great
of 2008 as having lost 8.4 million jobs thus far and no more than 1.4
jobs are expected to be restored by the end of 2010. Unemployment is
to stay near double digit for the foreseeable future. If workers who
up looking for work are also counted, the unemployment rate is close to
Some are attempting to put a positive spin on US
jobs numbers for February 2010 when the unemployment rate, though still
9.7%, held steady. The economy shed 36,000 jobs in January, but the
was that the pace of job loss was moderating. An average of 27,000 jobs
lost each month since November 2009, compared with 727,000 jobs a month
average over the same period in 2008. When the laws of gravity says
up must eventually come down, there is no law that say what goes down
eventually come back up. That is how swimmers get drown; they float
only after life has long left the body. Only dead bodies float
While the unemployment rate is rising more slowly, it seems
likely to remain high. And despite the recent policy insistence that
three priorities are jobs, jobs and jobs, both Congress and the Obama
administration are not taking concrete steps to create them quickly
usual lukewarm tax incentives.
By February 2010, 8.4 million jobs have been lost since the
financial crisis began in July 2007. The normal 2.7 million jobs needed
absorb new workers coming into the economy were never created, leaving
economy bereft of 11.1 million jobs. To fill that cumulative employment
while keeping a growing work force fully employed would require more
400,000 new jobs a month for the next three years, considerably in
even the most optimistic projections under current job creation
programs. Further, healthcare reform, if it is expected to save cost,
inevitably include a reduction of jobs.
Five states reported new highs for joblessness in January
2010: California, at
12.5%; South Carolina,
11.9%; North Carolina,
11.1%; and Georgia,
unemployment rate is still the nation’s highest, at 14.3%, followed by Nevada
with 13% and Rhode Island
at 12.7%. South Carolina
rounded out the top five.
Employers are unlikely to make new hires until they can
profitably restore their current part-time work force to full time. In
private sector, just restoring hours cut during the recession will
the equivalent of 2.8 million new jobs.
Congress is taking its time debating an undersized jobs bill
that is not expected to create anywhere near the jobs that the economy
2010. The good news is that during the second half of 2010, the economy
get a temporary, one-time job boost from the taking of the census,
hire about one million minimum wage temporary workers. The danger is
job statistics will allow both the Administration and Congress to avoid
meaningful job creation commitments needed for a genuine recovery.
forward, a jobless recovery has become a given when the recovery
with a working population of 131,456,000 as of June 2010 out of a total
of 307,000,000, had 14,600,000 workers unemployed, yielding an
rate of 9.5%. But Unemployment is not
equally shared among all worker types. Among teenagers it was 25.7%,
blacks was 15.4%, among Hispanics 12.4%, among whites 8.6% and among
In July, US
jobless rate held steady at 9.5%, while the government's broader
unemployment was also unchanged at 16.5%. The comprehensive gauge of
labor under utilization,
known as the “U-6” for its data classification by the Labor
Department, measures people who have stopped looking for
work or who cannot find full-time jobs.
Both rates held steady despite a drop in the number of
people who are employed. The number of unemployed people in the work
dropped, but that was more than offset by a decline in the overall size
work force still looking for work. Though more people were no longer in
labor force, fewer of those dropouts said they were currently looking
This helped keep the broader rate steady.
The labor force data were affected by a temporary end to
extended unemployment benefits. The Labor Department survey was
the Senate expanded an extended-jobless-benefits program through the
end of 2010.
Beginning in August 2010 many of those people who dropped out of the
force in the previous two months may return to active job seeking. If
number of jobs created remains as muted as it has been the previous few
it could send both unemployment rates higher.
The battle over the extension of unemployment benefits in
the Senate may be setting the stage for more bruising fights in the
not-too-distant future. Lawmakers on July 21, 2010 voted to continue eligibility for
benefits through late in the year. But if history is any guide, there
likely be at least one more call for an extension.
Meanwhile, the legislation allows job seekers to receive
unemployment benefits for up to 99 weeks, depending on their state of
In the coming months, the number of recipients who remain unemployed
weeks could increase substantially.
According to an analysis by Goldman Sachs
Phillips, unemployment benefits are extended an average of 23
following the peak in unemployment rate. In the current downturn, the
the jobless rate — 10.1% — came in October 2009. To reach the average,
unemployment benefits would need to be extended through September 2011,
would require another act of Congress.
Meanwhile, that extension would just cover the average. In
past recessions, unemployment extensions continued until the
dropped below 7.5%. That’s a big two percentage points from the 9.5%
recorded in June. Indeed, economists in the latest Wall Street Journal
forecasting survey see the rate still elevated at 8.6% in December
53% of people who start unemployment remaining unemployed through at
first 26 weeks — the highest level since records began in 1972 — it’s
take a long time before the unemployment system returns to something
At the same time, the ranks of those who have exhausted all 99
weeks of state and local benefits could be set to grow substantially.
those facing the 99-week deadline would be counted in the Labor Department’s tally of people
collecting joint state-federal extended benefits. That number has
around half a million in the June and July 2010, but could be set to
Before benefits expired in June when the Senate first failed to pass
benefits legislation, more than five million people were collecting
of extended unemployment insurance. Meanwhile, the Labor Department
June that 4.3 million Americans have been out of work for more than 52
Even if most of the long-term unemployed could find jobs
before they reach the 99-week threshold, the number of people bumping
against the 99-week ceiling could be set to rise substantially. One key
is the state of the job market 99 weeks ago (August 2008), as the
Brothers bankruptcy took place in September 2008 after which the true
hemorrhaging in jobs began. From January through August 2008, the
1.2 million jobs total. In just four months the total had jumped to 3.6
million, on its way to an 8.4 million total by the end of 2009. The
jobless benefits in Jul 1010 gave job seekers collecting benefits a
breathe slightly easier, but there may be more squeezes ahead.
The 9.5% unemployment rate is calculated based on people who
are without jobs, who are available to work and who have actively
in the prior four weeks. The “actively looking for work” definition is
broad, including people who contacted an employer, employment agency,
center or friends; sent out resumes or filled out applications; or
placed ads, among other things. The rate is calculated by dividing that
by the total number of people in the labor force.
The U-6 figure includes everyone in the official rate plus
“marginally attached workers” — those who are neither working nor
work, but say they want a job and have looked for work recently; and
are employed part-time for economic reasons, meaning they want
but took a part-time schedule instead because that’s all they could
Both the headline and U-6 rates are based on the number of
people in the labor force. When the unemployed drop out of the labor
completely the jobless rate declines. That problem has been exacerbated
current recession by the large number of people unemployed for a long
time. About 6.6 million people have been out of a job for more than 27
The government’s mid-2010 report on the job market was bleak, a sign
economic recovery is running out of steam with 14.6 million Americans
searching for work. Job growth proved anemic in July as governments cut
and private-sector employers barely expanded.
shed 131,000 jobs, as 143,000 temporary Census workers fell off federal
payrolls. Private-sector employment grew by 71,000 in July after a
revised 31,000 in June. Government employment, not counting Census
fell by 59,000.
The unemployment rate held steady at 9.5% largely because people gave
hope of finding work and left the labor force.
latest figures confirm the labor market has lost much of its momentum
months. The private sector has added 90,000 jobs a month on average so
year, well below the 125,000 needed monthly just to keep up with
growth, let alone recover the eight million jobs lost during the
Two-thirds of the private-sector job creation this year occurred in
April, when the economy’s trajectory appeared stronger.
The disappointing data initially sent the Dow Jones Industrial Average
160 points, but it recovered to end the day off 21 points to 10,653.56.
demand for safe U.S.
government debt pushed the 10-year Treasury yield down to 2.82 percent,
lowest level since April 2009. The two-year note fell to 0.514 percent
falling to an all-time low of 0.494 percent during the day.
The labor market report compounds pressure on Congress, the
White House and the Federal Reserve to do something to reignite
in the labor market.
At their policy meeting Tuesday, Fed officials plan to
discuss whether to take the small but symbolically important step of
reinvesting proceeds from its portfolio of mortgage-backed securities
maintain support for the economy. The weak jobs numbers add to the case
taking action, though officials must assess whether taking even a tiny
could create expectations for larger actions in coming months.
Even in expanding sectors, many employers remain wary of
adding jobs without strong evidence the economy won't take another turn
downward. The jobs report showed private-sector employers working their
employees longer rather than hiring new ones. Aggregate weekly hours
rose 0.3% overall, and 0.5% in manufacturing.
Temporary-help jobs, typically a leading indicator for the
rest of the labor market, fell in July. Temporary employment declined
after nine straight months of growth.
A weak labor market will keep incomes—and consumer spending,
which accounts for 70% of U.S.
economic output—under pressure. The Fed said on July 30 that consumer
declined at a 0.7% annual rate in June as consumers continued to pay
Revolving credit, mostly credit-card borrowing, fell at a 6.5% rate.
million people were jobless for more than 27 weeks in July, accounting
44.9% of all unemployed. Workers who are finding positions after long
are taking pay cuts to make ends meet.
The retail sector was among the areas to add jobs in July,
increasing by 7,000.
Health care added 27,000 jobs while manufacturing rose
36,000. Construction declined by 11,000.
Public Sector Layoffs
State and local governments shed 48,000 jobs, the most since
July 2009, as many governments started new fiscal years that required
cut budgets. Lawmakers in Washington
are set to clear a $26 billion package to aid state governments, but
only make a small dent in the longer-run problem facing governments. In
cities from Los Angeles, California
to Dallas, Texas,
to Trenton, New Jersey
either laid off workers or announced job cuts in their new fiscal
State and local governments shed 48,000 jobs in July, 2010, the
biggest drop in a year and almost double last month’s drop. State and
government have cut a combined 169,000 jobs in the first half of 2010,
including 102,000 over the second quarter. The latest report suggests
losses could continue to accelerate as states grapple with weak tax
and the loss of federal budget support in the second half of 2010l.
July is the
first month of most states’ 2011 fiscal year, so the month’s job losses
budget decisions that were made months ago but don’t translate to job
until the fiscal year turns on July 1, 2010.
Local governments shed 38,000 jobs in July 2010. States cut
10,000. Local government — everything from cities to school boards and
transportation districts — account for 14.3 million jobs, compared with
million for states. More people work in local government than in the
State governments had expected tax collections to rise in
2010 as their tax collections get a lift from tax increases and a
improving economy. The first half of 2010 turned out to be a huge
disappointment. But even if the second half of 2010 turns out to be the
for tax collections, governments are likely to continue cutting jobs
least a few more months.
Budget assistance provided in the federal stimulus act is
already starting to run out, and after widespread tax increases last
legislators have preferred to balance this year’s budgets (delivered in
election year) with cuts.
State governments saw year-over-year tax collections rise in
the first quarter for the first time since the outset of the recession,
revenues were well below pre-recession levels for most states.
State tax revenues increased 2.5% to $164.5 billion in the
quarter, according to an analysis of Census Bureau data released
Tuesday by the
Nelson A. Rockefeller Institute of Government at the State University
York. The Institute report said data from 42 states that have released
figures for April and May suggested that second-quarter revenues grew
1%. “Fiscal conditions remain fragile, indicating a long and bumpy road
recovery,” says Lucy Dadayan, senior policy analyst at the Rockefeller
The first-quarter gain was largely the result of tax
increases, driven by a 2.5% gain in personal income taxes and a 0.4%
in sales taxes. Corporate income taxes, which tend to be volatile, fell
from a year ago.
Changes in tax revenues tend to lag behind recessions
because it takes time for lost wages and thriftier spending to
lower income and sales taxes. Despite the recent improvement, state
are still under heavy stress. The $164.5 billion collected in the first
of the year was lower than the tally in the first quarter of 2006,
about a year
before the recession began.
While tax revenues have recovered from a free-fall that
persisted through much of 2008 and 2009, state budgets remain far from
Much of the first-quarter increase came from two states, California
and New York, that have
taxes to close budget gaps.
While states have seen modest tax growth, local-government
revenues have just started to fall. Census figures show that
revenues—the lion's share of them collected by local governments such
and school boards—fell 0.6% to $107.7 billion in the first quarter from
same period a year ago. That was the first year-over-year decrease in
taxes since the second quarter of 2003.
With tax revenues still lagging and the phasing out of state
assistance that was part of the $787 billion federal economic stimulus
state budgets are expected to be under strain for several years. A
report from the National Governors Association showed states still
billion in budget gaps over the next two years. Unlike last year,
deficits have been mostly rectified through program cuts instead of tax
The Federal government has added support to state budgets,
with the Senate
passing a bill that gives $26 billion to state and local governments.
government is also expected to extend state Medicaid support through
part of 2011.
Despite the new aid package, total federal aid to state and local
will be substantially less than it was in the height of the stimulus.
states that have released forecasts for their 2012 and 2013 fiscal
cumulative deficits estimated at $136.4 billion, according to a recent
by the National Conference of State
Legislatures (NCSL). With stimulus funds ending and growing
about the economic recovery, the NCSL report said, fiscal 2011 “may
turn out to
be the calm before the fiscal tempest.”
State and local governments shed 48,000 jobs, the most since
July 2009, as many governments started new fiscal years that required
cut budgets. Lawmakers in Washington
are set to clear a $26 billion package to aid state governments, but
only make a small dent in the longer-run problem facing governments. In
cities from Los Angeles, California
to Dallas, Texas,
to Trenton, New Jersey
either laid-off workers or announced job cuts in their new fiscal
The House of Representatives passed a bill on August 10, 2010 providing $26.1
billion to aid deficit-stricken state governments, and preventing some
teachers and 158,000 public works employees from being laid off
vote was 247-161
along partisan lines with Democrats for and Republican against.President Obama immediately signed the bill into law.
Democratic lawmakers pushed hard o pass the state aid legislation
before the start of the school year in hope of better results for
facing November mid-term elections.
Representative Barney Frank (D-Mass.) told the press: “The
frustration of course has been that the Republicans have a two-step
First of all, obstruct anything from getting better, and then point out
things aren't getting better.I mean the
bill that's being passed today, if it were passed a month ago, we
had the [Labor Department Bureau of Labor Statistics] job
report last week and I think they [Republicans] are fine with
Technically, the bill provides $10 billion to fund education
and $16 billion to fund Medicaid. However, many states have been
get the federal assistance and a majority have already budgeted for it
by July 1, 2010.
This means that that if
the funds were blocked, cuts would have to be made elsewhere – laying
firefighters, police officers and other state employees. The House was
in recess on August 5 when the Senate passed the jobs bill. But
more than willing to sacrifice a couple of days at home in their
get the bill passed, according to Frank who supports the bill.
Many of the jobs protected under this bill belong to teacher
unions or the American Federation of State, County and Municipal
both key parts of the Democrats' political base. But the case for
action has an
economic basis: Forcing layoffs at the state level counteracts federal
efforts and could push the economy toward a double-dip recession. And
off state workers, only to have them receive state unemployment checks,
little fiscal sense.
The next unemployment trouble will come from the public
sector. Without timely and adequate Federal aid, the states and local
governments will be forced by falling tax revenue to tighten fiscal
which will mean layoffs and cancelled private contracts, both of which
squeeze demand in the private sector to further reduce local government
in a downward spiral.