I thought about this problem with definitions last week when I read a Washington Post op-ed by Jared Bernstein. He was the chief economist for Vice President Joe Biden and now works at a left-of-center Washington think tank. He’s also not someone I would normally quote, since we are on quite different policy ground politically and economically. But we also have some common ground, and I think it’s important to note that. And for the record, more and more economists of all stripes are beginning to come around to this very same view. But Jared does a particularly good job in a brief space of framing the issues. Here’s the lead to Jared’s article. (The bold print is mine.)
Recent events have exposed a hole in the middle of economists’ knowledge of key economic parameters: We know neither the unemployment rate at full employment nor the potential level of gross domestic product (GDP).
That hole is particularly important right now. The combination of the deficit-financed tax cut and the new spending bill are pumping hundreds of billions into an economy that many argue is already at full employment. If so, then much of this extra spending won’t lead to new investment, jobs or higher real pay. When the economy’s human and capital resources are fully utilized (meaning actual GDP is equal to potential GDP), fiscal stimulus just generates inflation and higher interest rates. Even if the extra demand might create some wage pressure, it will be met with higher inflation, so real wages—the paycheck’s actual buying power—won’t change at all.
The problem is that those making that argument are implicitly asserting that they know that the “natural rate of unemployment”—the lowest rate consistent with stable inflation—is roughly equal to the current unemployment rate. That is, they believe we’re at full employment. But the truth is they have no way of knowing that, and one key indicator—inflation—suggests they may be wrong.
Those are three paragraphs that I could have written and defended. I think that fact is significant. Jared and I more than likely to disagree on what economic policies we should follow—but we can’t even have that argument until we can agree on what the data says and means. And we can’t at this point. We have to rely on anecdotes and hints, at best.
This state of affairs is startling once you start thinking about it. Economists are reaching conclusions and policymakers are making decisions based on derivatives of invisible derivatives.
Sound crazy? Yes, but it’s happening.
Giant Mystery
Let’s talk about these two stats, full employment and potential GDP. They have multiple layers.
“Full employment” means all the people who want to work are gainfully employed. For the record, the Fed thinks that full employment is an unemployment rate of about 4.7 percent, while the BLS tells us that unemployment is currently running at 4.1 percent. Those who aren’t working are either in between jobs or face some barrier, like a criminal record or lack of skills. Therefore, if we are indeed close to full employment, employers who need more help must offer higher wages, which leads to inflation. At least that has been the pattern historically.