Thursday, July 01, 2010

Jobless recoveries - mystery solved!!!

Bill Gavin and Menzie Chinn solve the mystery of the "jobless recoveries" we've been having since the early 90s:
In the earlier postwar recessions, the unemployment rate began to fall very quickly once the expansion began. By contrast, the unemployment rate continued to climb even after the recovery had begun for the 1990-91 and 2001 recessions. No one is predicting a rapid drop in the unemployment rate this time around, either...

Bill called my attention to the contribution of temporary layoffs to this changing behavior in the unemployment rate. He noted that the Social Security Amendments of 1958 explicitly exempted unemployment insurance from income taxation, and recalled a 1976 paper by Martin Feldstein which proposed that this gave firms a strong incentive to use temporary layoffs in response to a business downturn. By temporarily laying workers off rather than asking them to work shorter hours, the firm could deliver maximal after-tax compensation to its labor force, intending to hire those same workers back as soon as business improved. Temporary layoffs accounted for up to a quarter of those unemployed at the worst of the 1973-75 recession.

Bill believes that the key developments that changed this dynamic were the Revenue Act of 1978, which subjected unemployment benefits to partial taxation under the income tax law, and the Tax Reform Act of 1986, which made unemployment benefits taxable as ordinary income. Since the mid-1980s, the above graph shows that temporary layoffs have become a much less important feature of recessions...

If you subtract temporary layoffs from the number of unemployed, here's what the adjusted unemployment rate would look like. The earlier recessions look much more like the recent jobless recoveries.

Now THAT is good economics work. Simple, empirical, and predictive.

Perhaps we should consider once again exempting unemployment benefits from taxation.

No comments:

Post a Comment