Briefing Paper

Between the end of 1979 and the end of 1981 unemployment rose by 1.4 million. After that exceptional period unemployment continued to rise rather less rapidly to its current level of 3.2 million, Of this 3.2 million, about 1.3 million have been unemployed for more than a year. In this Briefing Paper we describe and attempt to explain the processes by which long-term unemployment rose to its current level.
We also discuss two related questions; the first concerns the relationship between unemployment and vacancies and the second concerns the relationship between long-term unemployment and inflation. The final sections consider the policy implications of these findings.     

Prospects for the world economy in the 1980's

Judged by the conventional measures of the growth of output and trade, of inflation and unemployment, the economic performance of the industrial countries has undergone a marked deterioration in recent years. It is now feared that a further deterioration could take place over the next decade leading to ever greater pressures within and between countries. In this Briefing Paper we attempt to measure the changes that have taken place, to identify their timing and the proximate causes. On the basis of recent developments and a historical perspective we try to judge the prospects for the 1980's.     

The Australian Economy - Thatcherism after 7 Years?

In March 1983 Mr Malcolm Fraser's Liberal Coalition was defeated in the Australian general election. He had held office for over 7years. His Government's record on economic management can be briefly summarised as follows. At the end of 1975 when the Liberal Coalition took office the inflation rate was 14 per cent and the rate of unemployment was 5.4 per cent; in March 1983 the inflation rate was 11.5 per cent and the rate of unemployment was 10.4 per cent. It is generally thought that Mr Fraser's policies were not unlike those of Mrs Thatcher. Since he had been operating them for over seven years it is reasonable to ask why the outcome appears to have been so disappointing. In this Briefing Paper we examine recent developments in the Australian economy and make some comparisons of policies and outcomes in Australia and Britain, particularly during the past four years, when there were conservative Governments in both countries.     

The Public Expenditure Debate

This Briefing Paper is concerned with the structural implications of public expenditure for economic performance. It examines the growing role of public expenditure in Britain over the past hundred years, and compares the current share of public spending in the UK with that in other developed countries. Since overall public expenditure does not appear to be a useful concept in the context of the structural debate, the distinctions between different types of public expenditure are emphasised The main purpose of the Briefing Paper is to clarify the current debate.     

Control Theory and Macroeconomic Policy

This Briefing Paper examines the contribution that control theory can make to our understanding of macroeconomic policy. Control theory is an area of study, orginally developed in engineering, which has since been applied to a very wide range of problems not only in engineering but also in biology. ecology, physiology, space exploration and economics. The kinds of questions in economics which conrrol theory could help us to answer include: what objectives should the government be pursuing, infation or unemployment or both, and by what means? what instruments should be used and in what combinations? should the government adopt targets for the money supply or the exchange rate, or concentrate on unemployment and the balance of payments?     

Forecasting Errors: the Track Record

This Briefing Paper is the last of a series of three about forecasting. In this one we examine our forecasting record; it complements the February paper in which we analysed the properties of our forecasting model in terms of the error bands attached to the central forecast.
There are many ways of measuring forecasting errors, and in the first part of this Briefing Paper we describe briefing how we have tackled the problem. (A more detailed analysis can be found in the Appendix.) In Part II we report and comment upon the errors in our forecasts of annual growth rates and show how our forecasting performance has improved over the years. In Part III we focus on quarterly forecasts up to 8 quarters ahead, and compare our forecasting errors with measurement errors in the oficial statistics; with the estimation errors built into our forecast equations; and with the stochastic model errors we reported last February. A brief summary of the main conclusions is given below.     

Trends and Cycles in GDP

The recent experience in the UK of substantial growth in GDP following the recession of the early 1980s has led to renewed interest in the measurement and explanation of business cycles. Development of economic as well as econometric theory has improved our ability both to measure the cycle more accurately and to offer a better explanation of its behaviour. In this Briefing Paper we present an analysis of these two developments.     

Monetary Targets and the World Economy

The dominant obsessions to watchers of the world economy at the moment are the weakness of the US dollar and the fear that the world economy is stagnating. In this ‘Briefing Paper’ we seek to put both events into the same intellectual framework, and to show that they are the consequence of monetary policies which are not logically related to each other, nor to a common objective of bringing world inflation steadily down to an acceptable level. Specifically, the US - which for reasons outlined below can warrant monetary growth rather below the world average if it is to preserve some dollar stability - is showing an above average outturn in its monetary aggregates. Germany and Japan, which can accommodate increases well above the average, are in fact adopting monetary targets which are leading to exchange rate appreciation, arid a reduction in both countries' expectations for real growth. The dangers for the world economy in this situation are very serious, particularly at a time when further dollar devaluation could be risky both from the viewpoint of US inflation wide the dollar's role as the key reserve asset. It could lead at worst to US protectionism and a monetaryled recession, rein forcing the slow growth rates already being widely predicted in 1978 for many other industrial countries. However, we show in this ‘Briefing Paper’ that this is not a necessity outcome of the present situation, given three vital perceptions. The first, required by statesmen as much as by technicians. is that the recent stagnation in European & Japanese output and exchange rate instability are essentially a monetary phenomenon, requiring essentially monetary (rather than fiscal) remedies. The second is acceptance of the need and practicability of some monetary consignation, based on reasonably common objectives among the major countries regarding inflation, bands for exchange rate movement and red rates of growth. the third, at the most practical level, is agreement on the actual monetary numbers which broadly reconcile these objectives and also take account of the very different ‘unwanted’ rates of monetary growth between countries which reflect their different underlying conditions of output, productivity and demand for money. It is the (ambitious) aim of this ‘Briefing Paper’ to substantiate these perceptions and to provide the numbers mound which a consideration of monetary policies can be framed. The numbers are necessarily based on trends established over a number of years and need to be supplemented by detailed understanding of each country's financial status But the monetary targets provided do, in our judgement, embody trade-offs between inflation, growth and exchange rate movements which should broadly satisfy national ambitions, and reset the world economy on a worthwhile growth path during 1978 or 1979.     

A Policy for Debt-Deflation

As recovery begins, the level of outstanding debt and the weakness of the housing market remain a major constraint on consumer spending. In this invited article Gordon Pepper sets out what is the appropriate policy repsonse to the problem of debt-deflation. In the Briefing Paper on page 39 Alistair Milne provides a detailed background.     

Growth and Unemployment: Towards a Theoretical Integration

We observe in the literature of the past decade some innovative contributions identified a relation between economic growth and long run unemployment. This set of contributions is composed of very few elements, all characterized by a high degree of heterogeneity about their features and about their final results.
In the first part of the survey we provide a classification of these early contributions. In the second part we explore some alternative formulations of the problem and we present a wider set of models displaying interesting features, able to promote further studies about the persistence of unemployment in a growing economy.     

Econometric Models and Economic Forecasting

This Briefing Paper is thejirst ofa series of three designeddiscussed is the process of making 'constant adjustments' in forecasts. This process involves modifying the results generated by the econometric model. For the first time we are publishing tables of the constant adjustments used in the current forecast. We explain in general why such adjustments are made and also explain the actual adjustments we have made for this forecast.
The second article of the series, to be published in our February 1983 edition, will describe the potential sources of error in forecasts. In particular it will describe the inevitable stochastic or random element involved in e tatistical attempts to quantify economic behaviour. As a completely new departure the article will report estimates of future errors based on stochastic simulations of the LBS. model and will provide statistical error bad for the main elements of the forecast.
The final article, to be published in our June 1983 edition, will contrast the measures of forecast error that e e obtain from the estimation process and our stochastic e imulationsp with the errors that we have actually made, as revealed by an examination of our forecasting 'track record'. It is hoped to draw, from this comparison, some e eneral conclusions about the scope and limits of econometric forecasting producers.     

Briefing Paper: Why has the economy recovered?1

By the end of last year GDP (though strike affected) was 9 per cent higher than in the first half of 1981, an annual growth rate of 2.5 per cent. In this Briefing Paper we seek to explain the recovery from the recession. We conclude that much of the recovery represents a natural response of the economy after the oil and price shocks of 1979-80. The recovery occurred in spite of the deflationary Budget of 1981 and the sharp rise in interest rates in the autumn of 1981. Since 1981 fiscal policy has been stable, whereas the original intention was to tighten fiscal policy progressively in subsequent years. This stability and the fall in the inflation rate that accompanied it allowed growth to resume. We believe that the upturn would have been rather weaker (though inflation would have been lower) if the progressive tightening of the original Medium- Term Financial Strategy had been adhered to.     

The Costs and Benefits of Cutting Inflation

In recent speeches Treasury Ministers have coined a new slogan. They argue that inflation is not an alternative to high unemployment but a fundamental cause of it. They use this slogan to attack those who suggest that thefight against inflation should be slackened - at least briefly - in order to reduce unemployment. In this Economic e iewpoint we examine the arguments about the relation between inflation and unemployment. We suggest that although inflation may be a cause of unemployment in the long term there is an inescapable short-term choice to be made between reducing unemployment and reducing inflation. We explain why this choice arises and also discuss the longer-term effects of counter-inflationary policies. Finally we examine the record of this Government's policies so far.     

Reconciling theory and empirics on the role of unemployment in mortgage default

Empirical models of mortgage default typically find that the influence of unemployment is negligible compared to other well known risk factors such as high borrower leverage or low borrower FICO scores. This is at odds with theory, which assigns a critical role to unemployment in the decision to stop payment on a mortgage. We help reconcile this divergence by employing a novel empirical strategy involving simulated unemployment histories to measure the severity of attenuation bias in loan-level estimations of default risk due to a borrower becoming unemployed. Attenuation bias results because individual data on unemployment status is unobserved, requiring that a market-wide unemployment rate be used as a proxy. Attenuation is extreme, with our results suggesting that the use of an aggregate unemployment rate in lieu of actual borrower unemployment status results in default risk from a borrower becoming unemployed being underestimated by a factor more than 100. In addition, our analysis indicates that adding the unemployment rate as a proxy for the missing borrower-specific unemployment indicator does not improve the accuracy of the estimated model over the specification without the proxy variable included. Hence, aggregate portfolio-level risk estimates for mortgage guarantors such as FHA also are not improved.These views represent those of the authors and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. This is a revised version of a paper that previously circulated under the title “Unemployment and Unobserved Credit Risk in the FHA Single Family Mortgage Insurance Fund (NBER Working Paper No. 18880). John Grigsby provided excellent research assistance. We appreciate the helpful comments of Andrew Haughwout, Wilbert van der Klaauw, the editor (Stuart Rosenthal) and referees, but remain responsible for any errors.     

Distribution and determinants of lifetime unemployment

The empirical literature on unemployment almost exclusively focuses on the duration of distinct unemployment spells. In contrast, we use a unique administrative micro data set for the time span 1975-2004 to investigate individual lifetime unemployment — defined as the cumulative length of all unemployment spells over a 25-year period. This new perspective enables us to answer questions regarding the long-term distribution and determinants of unemployment for birth cohorts 1950-1954. We show that lifetime unemployment is highly concentrated on a small part of the population. With censored quantile regressions we investigate the long-lasting influence of bad luck early in the professional career: Controlling for individual and firm characteristics we find that choosing at a young age what turns out to be an unfavorable occupation significantly increases the predicted amount of lifetime unemployment.     

Long-term Unemployment in the Canadian Labor Market

A bstract . Examination of the distribution of long-term unemployment in the Canadian labor market employing longitudinal administrative unemployment insurance data for the 1975–79 period indicates that over relatively long time periods, unemployment tends to be concentrated among those who have multiple unemployment episodes over time. By implication, high unemployment spell frequencies indicate a high propensity for re-employment. A great deal of long-term unemployment is found in lower skilled occupations and in seasonal occupations and industries. Youth and adult women comprise a proportion of long-term unemployed roughly commensurate with their share of the labor force.     

Savings, Personal Wealth and Risk

In this Briefing Paper we examine the underlying determinants of personal savings behaviour to substantiate our view that the recent fall in savings rates does not imply that it must in future bounce back to some more normal level. On the contrary there are good reasons for believing that savings are more likely to go on falling than to rise.
We argue that consumer behaviour should be related explicitly to personal wealth as well as to disposable income. Personal wealth has risen substantially since 1982: the fall in inflation and long-term interest rates has pushed up gilts' prices; the recovery of profits has sparked off a stock market boom; and the value of the housing stock, which is by far the most important asset held by the personal sector, has started to rise again in real terms. This rise in asset values means that, despite a rise in consumption financed by borrowing, the personal sector balance sheet still in a healthy state, particularly when account is taken of the personal savings now held indirectly via pension funds. These have risen rapidly recently, reducing the need for other long-term savings.
The rise in total wealth has increased savers' tolerance of a fall in net liquid assets (bank and building society deposits etc less borrowing). The willingness to hold a smaller (precautionary) stock of net liquid assets may also reflect a perceived reduction in risk. Financial markets have been much more stable over the period since 1975 than over the preceding eight years, and may now be signalling that the period of adjustment to the shocks and disturbances of the 1970s is drawing to an end. The fall in savings is a worldwide phenomenon. As in the UK it is linked to the fall in inflation and may also be connected with the recovery of the world's major stock markets.     

The ‘recession-push’ hypothesis reconsidered

The relationship between unemployment and self-employment has been studied extensively. Due to its complex, multifaceted nature, various scholars have found a large array of different results, so that the exact nature of the relation is still not clear. An important element of the relation is captured by the recession-push hypothesis which states that in times of high unemployment individuals are pushed into self-employment for lack of alternative sources of income such as paid employment. We make two contributions to this literature. First, we argue that official unemployment rates may not capture the ??true?? rate of unemployment as it does not include ??hidden?? unemployed who are out of the labour force. Therefore, we propose a new method where the ??recession-push?? effect relates not only to the (official) unemployed but also to the inactive population. Second, we argue that the magnitude of the recession-push effect is non-linear in the business cycle, i.e. the effect is disproportionally stronger when economic circumstances are worse. We provide empirical support for our hypotheses by estimating an econometric model on Spanish data.     

The Rational Expectations Revolution*

In the last decade there has been a major new development in economics – the Rational Expectations Revolution. Its supporters claim that it has permanently altered our whole approach to economics, particularly in the areas of policy-making and forecasting. Its critics argue that it is based on wholly unrealistic ideas about the possible sophistication of individuals in making economic decisions. This Briefing Paper offers a preliminary assessment of the Rational Expectations Revolution and indicates areas in which current research is active.