New Ideas about the

Long-Lasting Collapse of

Employment after the Financial

Crisis

Robert E. HallHoover Institution and Department of Economics

Stanford University

Woytinsky Lecture, University of Michigan

November 13, 2013

1

Collision of three forces

A decline in output demand—an event without seriousconsequences in a normal economy

The zero lower bound on the nominal interest rate

Low and stable inflation, so that the implied bound on thereal interest rate is constraining

2

The Financial Wedge

The difference between the rate of return to capital and thereal interest rate

ft =1

qt

[αytkt

+ (1 − δ)qt+1

]− 1 − rt

On the same conceptual footing as the investment wedge inChari-Kehoe-McGrattan, stated as an interest spread

Includes taxes and risk premium

3

The Financial Wedge

0

2

4

6

8

10

12

14

16

2009 2012 2015 2018 2021

Percen

t per year

4

The Ratio of Consumption to

Disposable Income

0.85

0.86

0.87

0.88

0.89

0.90

0.91

0.92

0.93

0.94

2006 2007 2008 2009 2010 2011 2012 2013

5

Real Household Liabilities

80

85

90

95

100

105

110

2006 2007 2008 2009 2010 2011 2012 2013

6

Burden of Deleveraging as a

Percent of Consumption

‐5

0

5

10nt of con

sumption

‐15

‐10

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Perce

7

Google searches for “withdrawal

penalty”

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010 2011 2012 2013

Inde

x value

8

In Equilibrium, the Real Interest

Rate is at the Level that Equates

Output Demand to Supply

‐0.025

‐0.020

‐0.015

‐0.010

‐0.005

0.000

0.005

0.010

0.015

0.020

0.025

0.94 0.96 0.98 1.00 1.02 1.04 1.06 1.08

Real interest ra

te

Output

Supply Demand

9

Excess Supply of Output when

the ZLB Binds

‐0.025

‐0.020

‐0.015

‐0.010

‐0.005

0.000

0.005

0.010

0.015

0.020

0.025

0.92 0.94 0.96 0.98 1.00 1.02 1.04 1.06 1.08

Real interest ra

te

Output

Supply Demand

Excess supplyof output

Interest rate bounded above equilibrium level

10

Real and nominal interest rates

Differ by the rate of inflation

Friedman: inflation depends on slack and an inertial termrelating to expectations

Sargent: inflation depends on the context

Central banks are firmly on the Friedman side, as expressedin the New Keynesian Calvo model

11

Recent inflation

Strongly anchored in the 1 to 3 percent per year range

Stock-Watson Jackson Hole paper 2010: no support forFriedman

Inflation falls a bit as the economy contracts but does notcontinue to fall despite several years of slack

This behavior contrasts to the Great Depression, whenextreme deflation occurred

12

Two Measures of U.S. Inflation

‐3

‐2

‐1

0

1

2

3

4

5

6

2006 2007 2008 2009 2010 2011 2012 2013

Total CPI

PCE core

Target

13

U.S. Wage Inflation

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2006 2007 2008 2009 2010 2011 2012 2013

14

Clashing theories of

unemployment

Most models of the ZLB take employment as determinedby product demand and unemployment as a residual

The reigning theory (DMP) links unemployment to theproduct market only in certain specific ways and does notsupport the idea that unemployment is just a residual

Recent work goes beyond the residual theory and integratessome version of DMP in a complete GE model

15

ZLB Analysis with Shifts in Both

Demand and Supply

‐0.025

‐0.020

‐0.015

‐0.010

‐0.005

0.000

0.005

0.010

0.015

0.020

0.025

0.90 0.95 1.00 1.05 1.10

Real interest ra

te= minus infla

tion

Output

Supply

Demand

16

DMP model

Focuses on the job-creation decision of the employer

When an employer adds a worker, the employer gains thepresent value of the difference between the worker’smarginal contribution to revenue (the marginal revenueproduct of labor) and the worker’s pay

This present value is the job value

To reach the point where this gain occurs, the employerexpends recruiting effort. The net benefit to the employeris the job value less the cost of recruiting a worker. Withfree entry to hiring, employers push recruiting effort to thepoint where the net benefit is zero. Thus the job valuecontrols the amount of recruiting effort

17

Job value and unemployment

Positive relation between recruiting effort and the speedwith which job-seekers find jobs

When employers are making high effort—posting manyvacancies and advertising their existence—job-seekers findjobs quickly

Unemployment is then low

18

Models of fluctuations in job

value and thus in unemployment

Walsh: In the New Keynesian model, the marginal revenueproduct of labor falls in recessions, which lowers the jobvalue

Mortensen: Sticky prices result in depressed prices forintermediate products, and the job value falls at firmsmaking those products

Gertler-Sala-Trigari: Sticky wages result in lower job valuewhen the marginal product of labor falls

19

Most recent suggestions

Hall: In times of high risk premiums, when the stockmarket is low, the same risk premiums result in lowdiscounted values of the future flow of value from a newlyhired worker

Hagedorn, Karahan, Manovskii, and Mitman: Higher UIbenefits raise workers’ outside option in wage bargainingand lower the job value

20

Job Value from JOLTS Compared

to Wilshire Stock-Market Index

 ‐

 2,000

 4,000

 6,000

 8,000

 10,000

 12,000

 14,000

 16,000

 18,000

0

200

400

600

800

1000

1200

1400

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Job value(right scale)

Stock market(right scale)

21

Wage channel

HKMM find that the wage channel raised unemploymentby 3.1 percentage points in 2010

Compare adjacent counties in different states—same localconditions but different UI durations

22

Amplification through UI

extensions

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0 0.2 0.4 0.6 0.8 1 1.2

Une

mploymen

t rate

Duration of UI benefits

Small adverse shift condtional on unemployment

Large increase in unemployment induced through extension of UI benefits

UI policy Unemploy‐ment response

23

Evaluation of HKMM

Strong endogeneity of UI duration because of triggers anddiscretionary extensions plainly motivated by highunemployment

Some of the counties have population centers hundreds ofmiles apart

Questionable data on unemployment, but results for wages,vacancies, and employment are supportive

Detailed evaluation on my website

24

Duration of average spell of UI

coverage, months

0

2

4

6

8

10

12

1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

25

Index of real unemployment

benefits per month

0.0

0.5

1.0

1.5

2.0

2.5

1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

26

The job value is back to normal

but unemployment is 7.3 percent

I Declining matching efficiency lowers job-finding rateand raises unemployment

I In particular, more generous UI benefits may cutsearch effort and reduce matching efficiency (moralhazard)

I Declining turnover lowers unemployment

I Higher dispersion across labor markets raises averageunemployment

I Lower labor-force participation may lowerunemployment

I It takes time to work off a stock of high-duration, lowre-employment rate unemployed

27

Analysis of matching efficiency

“Measuring Matching Efficiency with HeterogeneousJobseekers” with Sam Schulhofer-Wohl

Based on CPS adjusted transition rates among 6 categoriesof unemployment, 2 categories of employment, andout-of-labor-force

Directly related to shifts of the Beveridge curve: Lowermatching efficiency implies outward shift of curve

28

Tightness

Tt =VtHt

29

Aggregate tightness

0.0

0.2

0.4

0.6

0.8

1.0va

ca

ncie

s/h

ire

s

2001 2003 2005 2007 2009 2011

30

Matching efficiency

fi,t = γi,tTt

γi,t =fi,tTt

31

Overall matching efficiency

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2001 2003 2005 2007 2009 2011

fixed component weights

fixed distribution of observables

32

Counterfactual unemployment

rate with pre-recession tightness

0.00

0.02

0.04

0.06

0.08

0.10

2007 2008 2009 2010 2011 2012

simulated baseline

counterfactual33

Moral-hazard effect of UI

benefits

Farber-Valletta is the most recent paper, confirming smalleffect of less than 0.5 percentage points

They look at how rapidly job-seekers find work and leavethe labor force, given unemployment and employmentgrowth in the local market

34

Coefficient of variation of

unemployment rate across 9

regions

0.00

0.05

0.10

0.15

0.20

0.25

0.30

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

35

Coefficient of variation of

unemployment rate across 29

occupations

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

36

Two measures of turnover rate

0

2

4

6

8

10h

ire

s (

mill

ion

s)

2001 2003 2005 2007 2009 2011

Current Population Survey

Job Openings and Labor Turnover Survey

37

Two measures of the labor-force

participation rate

61

62

63

64

65

66

67

68

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Standard participation rate

Extended participation rateAdding those who want a job, have searched for work during the prior 12 months, and were available to take a job during the reference week, but had not looked for work in the past 4 weeks.

38

Conclusions

The crisis depressed the job value substantially and theDMP model can be integrated into a GE modelconvincingly; there is no clash

The drop in job value resulted from higher discounts andother factors triggered by the crisis; UI extensions a factorbut probably not very large

With the job value back to normal, unemployment remainsat 7.3 percent primarily because of the overhang oflong-duration unemployment and secondarily because ofdeclining match efficiency, including the moral hazardeffects of UI

The remaining effects of the crisis operate through thecollapse of labor-force participation

39

Further readingReferences

Farber, Henry S. and Robert G. Valletta, “Do Extended Unemployment Benefits Lengthen

Unemployment Spells? Evidence from Recent Cycles in the U.S. Labor Market,” Work-

ing Paper 19048, National Bureau of Economic Research May 2013.

Gertler, Mark and Antonella Trigari, “Unemployment Fluctuations with Staggered Nash

Wage Bargaining,” The Journal of Political Economy, 2009, 117 (1), 38–86.

, Luca Sala, and Antonella Trigari, “An Estimated Monetary DSGE Model with Un-

employment and Staggered Nominal Wage Bargaining,” Journal of Money, Credit and

Banking, 2008, 40 (8), 1713–1764.

Hagedorn, Marcus, Fatih Karahan, Iourii Manovskii, and Kurt Mitman, “Unemployment

Benefits and Unemployment in the Great Recession: The Role of Macro Effects,” Oc-

tober 2013. National Bureau of Economic Research Working Paper 19499.

Hall, Robert E., “High Discounts and High Unemployment,” June 2013. Hoover Institution,

Stanford University.

, “Some Observations on Hagedorn, Karahan, Manovskii, and Mitman, “Unemploy-

ment Benefits and Unemployment in the Great Recession: The Role of Macro Effects”,”

November 2013. Hoover Institution, Stanford University.

and Sam Schulhofer-Wohl, “Measuring Matching Effciency with Heterogeneous Job-

seekers,” November 2013.

Mortensen, Dale T., “Comments on Hall’s Clashing Theories of Unemployment,” July 2011.

Department of Economics, Northwestern University.

Stock, James H. and Mark W. Watson, “Modeling Inflation After the Crisis,” Working

Paper 16488, National Bureau of Economic Research October 2010.

Walsh, Carl E., “Labor Market Search and Monetary Shocks,” in S. Altug, J. Chadha, and

C. Nolan, eds., Elements of Dynamic Macroeconomic Analysis, Cambridge University

Press, 2003, pp. 451–486.

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