WHY IS UNEMPLOYMENT WORSE THAN EXPECTED?

WHY IS UNEMPLOYMENT WORSE THAN EXPECTED? Two good economists raised a similar question this week about why the unemployment rate is higher than economic models would have predicted. Arnold Kling posted here on January 15: “I would suggest that explaining the depth of the recession is a challenge for just about any macroeconomist. There is no well-established theory that can explain how we got to 10 percent unemployment.” J. Bradford DeLong posted here (and here in the Wall Street Journal) on January 20: “Fourteen months ago…most of us would have bet that the U.S. unemployment rate today would be something like 7.5%….A 5% unemployment rate as of the end of 2009 would have been seen from a late-2008 perspective as a very good and lucky outcome, and a 10% unemployment rate would have been seen as a very bad and unlucky outcome.” Both economists have interesting discussions of possible explanations for why usual macroeconomic models have not predicted 10% unemployment.

Kids, I want to call attention to a very simple-minded explanation, which both economists actually address in their articles. I posted here, on the subject of computer models, that nature doesn’t run very good experiments. Nature also doesn’t run very many experiments at all. If there is a recession every four years, you’d have to go back some 40 years to 1970 to provide a data base of 10 examples. And the economy has changed dramatically in 40 years. Any prediction of unemployment of necessity has to have a large standard of error. Professor DeLong points this out by giving a range of 5% to !0%, depending on how lucky you are. Both economists address ways that the current recession is different from those in the past that contributed data to the models. For example, Professor DeLong’s first two points are that the financial collapse did more damage than in other recessions and that the stimulus package was different than in other recessions. I submit that perhaps the most useful result of the predictions of the computer models is to provide a base line for explanations by economists.

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