The weak labor market is still a demand problem

The Weak Labor Market Is About Demand  

The Weak Labor Market Is About Demand  

A blog about business and economics.
July 6 2012 10:26 AM

The Weak Labor Market Is Still a Demand Problem


Above you'll find the Cleveland Federal Reserve's inflation expectations yield curve chart. You'll see that in May inflation was expected to be low and in June inflation was expected to be lower.

Inflation—higher prices—is annoying, so one often thinks of a reduction in expected inflation as good news. But when you hear about lower prices in the future, you ought to ask "why?" One possible reason is positive supply shocks. If we think of some radically cheaper way to build solar-powered cars, that will reduce prices. But another possible reason is negative demand shocks. If everyone gets poorer and more unemployed in the future, the price of gasoline and housing will fall. One is great news, the other is bad news.


So how can we tell which is which?

Well, looking at the job market would be a good approach. As we saw today, June employment growth was pretty bad. Low and falling inflation expectations combined with a weak labor market are a telltale sign of excessively weak demand. The United States, like all countries at all times, also has some less-than-ideal supply-side policies. But when bad supply-side policies—or simply bad supply-side luck like an oil shock—are the dominant factor in the economy, you see joblessness and rising prices. Bad supply-side policies lead to scarcity, which leads to high prices. Bad demand-side policies lead to excess capacity, which leads to low prices.

Since President Obama has pursued a wide range of policies that conservatives disagree with, there's an incentive to try to gin up arguments to the effect that these bad policies are what's ailing the economy. But the aggregate evidence from inflation and employment is pretty clear—whether or not Obama's tax and regulatory policies are good or bad, the dominant factor in the labor market today is weak demand.