Can Government Help with Structural Unemployment?

Last Updated Aug 25, 2010 12:06 AM EDT

Minneapolis Fed President Narayana Kocherlakota and others have been arguing that there is little the Fed can do about the unemployment problem because it is mainly structural in nature. I don't agree with that conclusion. I think there's a large cyclical component no matter how the data are cut, but let's focus on the structural component for a moment.

The first point is that the rate at which the structural transformation will take place depends upon the rate of business investment. Long-term real interest rates -- the focus of quantitative easing -- can certainly be used to influence the rate of investment. Minimally, the Fed needs to what it can to prevent real rates from increasing due to falling inflationary expectations. The cheaper it is to make the transformation, something the Fed can influence, the faster it will happen.

Second, while we wait for the structural transformation to take place, fiscal policy can be used to bridge the gap. Suppose that the local community decides to tear down a school and build a much improved version in its place. Should we send all the students home on vacation while the new school is built, teachers too -- they would be structurally unemployed and need unemployment compensation -- or should we build temporary facilities to use while the new school is being built? Fiscal policy can be used to create temporary opportunities for unemployed workers while the structural transformations are taking place. It's true that structural change can prolong the adjustment period, but that means there's more of a need for such temporary facilities that provide employment -- more of a need for government help -- not less.

Third, there are other things fiscal authorities can do to encourage structural transformations, e.g. investment tax credits, incentives to bring new businesses and the unemployed together by moving labor to the jobs or encouraging new businesses to locate where unemployment is highest, retraining programs, etc.

Finally, I am convinced that this is primarily a demand problem. Even if you believe that there is substantial structural change that must take place, it's hard to deny that there is also a deficiency in demand right now. Creating more demand through an additional stimulus package would help to spur demand at businesses leading to higher profits, more confidence, and, importantly, more investment in structural transformation activities.

We have both cyclical and structural problems. We are in a situation where action from both the Fed and Congress could help, and neither alone is likely to be enough, but neither seems inclined to do anything. Both say that if things take a turn for the worse they will, of course, do more, but how bad to things need to get to move them to action? The Fed in particular has acknowledged there is more it could do, it just doesn't think there's any need, not yet anyway. Or, it says it's powerless because the problem is structural -- there's always an excuse to forestall further action. But we don't need evidence that things are even worse before implementing more aggressive policy, there's little to suggest we are on the robust road to recovery, things are bad enough presently, and the structural excuse does not let the Fed off the hook. Both the Fed and Congress need to take action now.

Even if you think there should only be action if things get worse, if we wait until we actually see the bad outcome, it's too late to do much about it due to the lags in the policy process. It takes time to put policy into place, and time for policy to work after Congress of the Fed acts, so ideally policy needs to be acted upon months in advance.

Policymakers keep making this mistake. Things look tenuous -- and there are plenty of worrisome signs right now -- but then they make excuses, adopt rosy scenarios, and find other ways to wait until they actually see the bad outcome before moving to action. It's like covering yourself up after the blow. Or saying you'll close the barn door if you see the horses running toward it. Who'll get there first? There's plenty to suggest that we need to insure against the chance that things will get much worse, or simply stagnate. In any case, we need to try to offset the problems we already have. But yet, there's no action. It's frustrating to see conditions so bad, with signs they could get worse, and have no sense of urgency from policymakers.

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