Wednesday, July 8, 2009

Yellow weeds and Stimulus 3.0!

The higher than expected June job loss figures for the US economy, especially after the encouraging slowdown in job losses in May, has raised serious doubts about the prospects of economic recovery. The economy lost 467,000 jobs in June, taking the unemployment rate to a 26 year high of 9.5%, challenging visions of green shoots in the landscape.

The Labor Department's broadest measure of unemployment, which includes part-time workers who would like to work full-time and those who have stopped looking for work, touched 16.5%. So far 6.5 million jobs have been lost since the recession began in December 2007, equal to the net job gain over the previous nine years. In terms of job losses, the present recession has surpassed all other recent recessions, with a net loss of about 4.7% of its nonfarm payroll jobs since the onset of recession.

In a prophetic verdict that echoes of his previous unheeded warnings, Nouriel Roubini has warns that labor market conditions are worsening, "The June employment report suggests that the alleged ‘green shoots’ are mostly yellow weeds that may eventually turn into brown manure." He also predicts the unemployment rate to peak at around 11% sometime in 2010, and feels that even if the recession comes to an end later this year, job losses will continue for a year-and-a-half or more. He argues that since both the hourly wages and the number of working hours are declining along with jobs, the impact on consumer confidence and consumption could be severe, with the result that most of the tax cuts in the stimulus could end up getting saved than spent. All this would keep retail sales and industrial production weak.

Further, the impact of this on the loan portfolios of the stricken banks in terms of loan losses, mortgage delinquencies, and lower recovery rates could be much bigger than what even the adverse scenarios (10.3% unemployment rate) of the stress tests predicted. He also feels that the home prices which have fallen from its peak by abouyt 27% will fall by another 40-45% before bottoming out, leaving more than half the households with mortgage with a negative equity in their homes.

He therefore writes, "The job market report is essentially the tip of the iceberg. It’s a significant signal of the weaknesses in the economy. It affects consumer confidence. It affects labor income. It affects consumption. It affects the willingness of firms to start increasing production. It has significant consequences of the housing market. And it has significant consequences, of course, on the banking system." With all this, he predicts that a double-dip W-shaped recession in 2010-11 is a possibility, more so if the massive deficits gets moentized and sets off an inflationary spiral.

It is in this context that there have been increasing calls for a third round (it is actually the third, after the tax-cuts of February 2008 and ARRA) of another round of fiscal stimulus on the grounds that "if we wait to see whether round one did the trick, round two won’t have much chance of doing a lot of good before late 2010 or beyond".

As Calculated Risk depicts in a nice graph, the job losses has far exceeded the predictions of Christina Romer and Jared Bernstein in their assessment of the impact of ARRA on jobs.

Therefore, making the case for another round of fiscal stimulus, Paul Krugman writes, "The problem is not that the stimulus is working more slowly than expected; it was never expected to do very much this soon. The problem, instead, is that the hole the stimulus needs to fill is much bigger than predicted.

And Brad De Long too weighs in favor, "If the Obama fiscal boost program has its anticipated impact on the economy as its main effects take hold over the next year, it is still half the size of the program it now looks like we need. Only if it magically turns out to be twice as strong as we think--only with simple Keynesian multipliers of 3 rather than 1.5 - is it the right size. And, of course, if the situation deteriorates further we will need an even bigger stimulus, while if the situation improves having too-big a stimulus is not a problem because we can soak up the demand through monetary policy." See also Mark Thoma here for a summary.

Update 1
Floyd Norris examines the extent of crisis in job losses here.

Update 2
Economix summarizes the list of those for and against Stimulus 3.0 here.

Update 3
Nouriel Roubini feels that the risks of a double-dip W-shaped recession are rising, "Thus, even as mounting job losses undermine consumption, housing prices, banks’ balance sheets, support for free trade, and public finances, the room for further policy stimulus is becoming narrower. Indeed, not only are governments running out of fiscal bullets as debt surges, but monetary policy is having little short-run traction in economies suffering insolvency — not just liquidity — problems. Worse still, in the medium turn the monetary overhang may lead to significant inflationary risks."

Update 4
Roubini again that W-shaped recovery is more looking likely.

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