I have a couple of alternate explanations to what Scott Sumner presents in his account for why the falling unemployment rate is not necessarily translating into higher GDP growth, and why the yield curve has flattened.

The first evidence I have is the graph of estimated real interest rates provided by the Cleveland Fed (released July 24, 2014) showing that real interest rates are still negative and the assumption that real rates must be positive by now is not accurate. This chart suggests that not much has changed over the last few years, except real interest rates over the last few quarters have sunk slightly farther into negative territory.


If this is an accurate estimate and, for now, it’s likely the only one we have, it really is just another way of demonstrating that money is still tight with the Fed at the ZLB and IoER still positive. QE 3 was sort of an attempt to fill in the gap for a monetary regime that breaks when we most need it to work – putting it together with bubblegum and bailing wire, that has now been abandoned even though the job is not finished. Thus I am a bit skeptical about whether the employment picture is nearly as rosy as it appears on the surface.

First of all, the “baby-boomers retiring” meme has already been debunked with a simple graph of employment growth by age group posted by Marcus Nunes. I am not sure why it is still used as an explanation for anything as it is almost entirely fable and cannot explain slow LFPR growth – but tight money that is allowed to grow tighter with the ebbs and flows of geopolitical conditions, poor monetary conditions in our closest trading partners (the EZ) and bets that the Feds has its eyes wide shut regarding the future certainly can. It also discounts that there are more millennials and the generation behind it than there are boomers (my generation, generation X is the smallest at 47 million). Also, sort of parenthetical to the demographic debate, the boomer generation consists of at least two decades while later generational designations are shorter, serving to create a cognitive illusion in discussions of generalities. Perhaps the boomers retiring meme is just one of those superficially plausible myths that make people feel better about the sorry state of economic and monetary affairs. But I think that holding onto it does more to mask the real damage to the labor market from persistently tight money than to repair it, and we’d be better off letting go of it.


If just these two facts are correct, which I believe they are, it explains why better than average job growth over the last few quarters is not translating into either more growth in RGDP or NGDP – there is still a considerable amount of slack and not much in the way of investments to improve productivity. Firms are making do with what they have against what appears to be a condition of static low demand. An example might be that the PC I was issued to do my job was at least two years old when I got it. I’ve had it for a little more than 18 months and as far as I am aware there’s no plan to replace it or make any significant upgrades to the software. The other kinds of technology investments being made of which I am aware are almost entirely about doing the same work with less, streamlining and consolidation of infrastructure, rather than achieving productivity gains – two entirely different engineering tasks. Of course these are only anecdotal examples from one firm in one industry. But I see the competitors doing the same things – trying to reduce costs, getting the same for much less (We’ll run your mess for less – they don’t particularly care about the mess at this point in time thinking they don’t have the money to clean it up).

My guess is that the drop in headline unemployment over the last couple of years has been due to a combination of factors that include stabilization of monetary policy that was presented by open-ended QE, natural wage adjustment, labor force dropouts and those who declined to enter, a reduction in initial claims (we’re not firing as many people per week), and we’re creating more jobs than we’re losing. But we still have not made up all of the lost jobs and jobs that needed to be created to keep up with population growth.

I made post about what it would take to get to the LFPR of 2007 with a headline unemployment rate of 5.5% using a calculator provided by a regional Federal Reserve Bank (here), 750k, and we’re nowhere near that. It takes into account only the working age population forecasted 10 years out (forget retirees already – they are factored in and we still need 750k jobs gained per month to catch up in 5 years!).

RGDP and NGDP growth is slow because we aren’t recovered, and we’re not getting that way any time soon. The markets “know” that is the new normal, hence the yield curve flattening just like growth is flat for the same reason and cause – tight money that is showing little sign of abatement.