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Labor market conditions: good or not so good?

The April U.S. employment report showed that nonfarm payrolls rose by 288,000 from March to April. This gain was the largest since January 2012. However, other measures suggest that labor market conditions may not be as strong as the headlines suggest. One key measure that economists regularly track is the employment-to-population (EP) ratio. The numerator in the EP ratio is civilian employment. The denominator is the civilian population. Both series come from the household survey. The ratio thus captures key variables of labor market conditions, such as population growth and the percentage of the population that is working and thus participating in the labor force.

Why do economists look at the EP ratio? The key reason, in short, is that the EP ratio is a key input in a standard growth accounting framework. In this framework, real GDP is the product of (1) real GDP per worker, (2) the percentage of the population that is employed, and (3) the civilian population. The first term approximates labor productivity and the second term is the EP ratio. Mathematically, we can transform each of the three components into growth rates and then add them together to produce real GDP growth. Since population growth tends to change very little in the short-to-medium term, the growth accounting framework is useful because it shows why real GDP growth accelerates or slows. Thus, has real GDP growth changed because of changes to the growth of labor productivity, EP ratio, or some combination of the two? One reason why average real GDP growth during this expansion (2.24 percent) has been so slow is that labor productivity growth has been relatively slow: 1.48 percent per quarter (annualized) through the first quarter of 2014. As shown in the graph, the other reason is that the EP ratio is still below the level that prevailed at the trough of the past recession (second quarter of 2009). Since then, the EP ratio has declined by an average of 0.26 percent per quarter (annualized). Until the growth of the EP ratio strengthens, the pace of the economy’s growth will remain quite modest. That is, assuming population growth remains constant, if labor productivity growth doesn’t accelerate, neither will economic growth.

Suggested by Kevin Kliesen

How this graph was created: In FRED, enter “Civilian employment to population ratio” in the search box. The data are in levels (no transformation).

View on FRED, series used in this post: EMRATIO

The Fed’s “tapering”: a nonevent?

In the weeks leading up to the June 18-19, 2013, FOMC meeting, financial markets were fixated on the possibility that the FOMC would soon begin to slow the pace of its large-scale asset purchase program—which at that point was $85 billion per month. In his press conference following this meeting, Chairman Bernanke said that “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” By the time the FOMC finally voted to slow the pace of its asset purchases at the conclusion of its December 17-18 meeting, the 10-year Treasury yield had risen from 1.66 percent on May 2 to 2.85 percent on December 18. The period of rising interest rates before the FOMC began to officially slow the pace of its asset purchases is sometimes referred to as the “taper tantrum.” This development led some analysts to conclude that financial markets would not react well when the real tapering got underway. Well, it hasn’t quite worked out that way.

This graph plots the St. Louis Fed’s Financial Stress Index (STLFSI) since Oct. 1, 2009. In the STLFSI, values above zero are defined as periods of above-average levels of financial market stress and values below zero are defined as periods of below-average levels of stress. Zero is considered average. The STLFSI rose sharply (became less negative) from the week ending May 17 to the week ending July 5. However, since early July it has steadily drifted lower. Moreover, since the December 2013 meeting, when the FOMC first voted to reduce the pace of its asset purchases by $10 billion per month, the STLFSI has fallen even further. Indeed, for the week ending April 25, 2014, the STLFSI was at its lowest level since mid-March 2013. All of this suggests that the Fed’s decision to steadily slow the pace of its asset purchases—currently $45 billion per month after the conclusion of the April 29-30 FOMC meeting—is having little adverse effect on financial markets.

An alternative, though perhaps complimentary view, is that the markets see what the Fed sees: A steadily improving economy and a continued low and stable inflation outlook.

How this graph was created: In FRED, enter “St. Louis Fed Financial Stress Index” in the search box. The data are in levels (no transformation). The beginning period was adjusted to show data since Oct. 1, 2009.

Suggested by Kevin Kliesen.

View on FRED, series used in this post: STLFSI

The ECB’s balance sheet continues to contract

At the press conference following the European Central Bank’s (ECB) meeting of the Governing Council on April 3, 2014, ECB President Mario Draghi commented on the state of the European economy and the scope of possible policy responses: He said that, in light of an “overall subdued outlook for inflation” and the “broad-based weakness of the economy,” the Governing Council “is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation.” In today’s meeting, the ECB reaffirmed the possibility of using unconventional instruments, if necessary, to achieve its mandate.

Understandably, European financial markets have been speculating that the ECB will soon begin purchasing assets. This policy action, commonly known as quantitative easing (QE), would increase the size of the ECB’s balance sheet, though not necessarily in the same manner as QE has increased the size of the Fed’s balance sheet. As Draghi noted, the purpose of implementing a QE-style monetary program would be to accelerate the pace of real GDP growth, which remains sluggish, and raise inflation, which remains about 1.5 percentage points below its 2% target rate. The chart, which shows the asset side of the ECB’s balance sheet, illustrates why some European economic analysts expect the ECB to soon put in place a QE program. Unlike the Fed’s balance sheet, which continues to increase, the ECB’s balance sheet—as measured by the asset side—has been contracting for almost two years. Since July 2012, the ECB’s balance sheet has declined from a little less than 3.2 trillion euros to about 2.2 trillion euros. Many economists have found this decline a little puzzling, given that the ECB’s balance sheet was contracting as Europe fell into a recession (see this presentation by St. Louis Fed President Bullard). Whether this policy will succeed as intended is another matter: U.S. economists continue to debate the effectiveness of the Fed’s QE programs.

How this graph was created: In FRED, enter “ECB Assets” in the search box. The data are in levels (no transformation).

Suggested by Kevin Kliesen

View on FRED, series used in this post: ECBASSETS

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