Low unemployment: Root of all evil?

Yes, according to this piece: “Other Times Unemployment Has Been This Low, It Didn’t End Well

There have been only three fleeting periods in the past half-century when the U.S. unemployment rate was as low as it is today.

This would be cause for celebration but for one disturbing fact: in hindsight, each period was associated with boiling excesses that led to serious economic trouble.

Low unemployment of the late 1960s preceded an inflation spiral in the 1970s. The late 1990s bred the Dot-com bubble and bust. The mid-2000s saw the buildup and collapse of U.S. housing.

While there is reason to believe today’s economy isn’t boiling over as in the past, those episodes call for caution.

“It’s not a matter of superstition, it’s a matter of being mindful of the history of what such a low unemployment rate usually is followed by,” said Michael Feroli, chief U.S. economist of J.P. Morgan Chase & Co.

By episode:

1.

While initially a welcome development, low unemployment in the 1960s laid the groundwork for a buildup of wage and price pressures, spurred on by low interest rates and aggressive government spending programs.

The unemployment rate dropped to 4.3% in September 1965 and then below 4%. Today’s unemployment rate, also at 4.3%, could drop below 4% in the next year if it maintains its present trajectory.

Low unemployment did not lay the groundwork for anything. As the chart illustrates, the rise in inflation was the child of “irresponsible” monetary policy that put nominal spending growth on an upward trend.

2.

Unemployment returned again to 4.3% in January 1999. This time the inflation rate remained below 2% and it seemed that, unlike the late 1960s, the economy wasn’t overheating.

But asset prices—the stock market in particular—soared after what had already been a long climb. The Dow Jones Industrial Average shot above 10000 for the first time in March 1998. Highflying tech companies commanded billion-dollar valuations with no profits to report. In hindsight, an internet bubble grew out of control.

Illustrating again: Inflation remained low and stable because monetary policy was “responsible”.

It wasn´t asset prices that soared, but the Nasdaq in particular. Strong productivity growth and the siren song of technology companies were the “culprits”, certainly not low unemployment (and low inflation).

3.

Unemployment fell back to 4.4% by October 2006. It coincided with a home- price boom that happened even though broader inflation measures remained stable. When home prices fell, a financial sector deeply exposed to mortgage credit collapsed and the economy entered the longest and deepest recession since the Great Depression.

A “coincidence” is just that. But the statement is not even true. Booming house prices had begun almost ten years earlier. When unemployment fell to 4.4% house prices had already peaked. The house price boom was the consequence of many things, among them distorted public policy leading to moral hazard. Certainly not a consequence of low unemployment.

The conclusion “throws the argument away”!

There is no telling how long this low unemployment period will last. Previous episodes of low unemployment went from a few months to several years with no predictable regularity or end. Still, the broader historical lesson looms: Eventually, these low unemployment cycles end.

Yes, they do end, but only when, given low inflation, monetary policy becomes “inadequate” or, in the extreme, “irresponsible”. The charts illustrate.

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