Rising Unemployment Will Lead to Further Economic Declines

Posted by Michael A. Kamperman on April 23, 2009

This morning the Labor Department reported weekly unemployment claims rose to 640,000.  The unemployment rate for April will rise again and job losses will be comparable to the job losses in March.  Unemployment is normally considered a lagging indicator as jobs don’t usually come back until the economy already starts to recover.  But I think it is different this time.  The theory that unemployment is a lagging indicator is built off of the normal business cycle.  In the normal post World War II recession supply eventually exceeds demand and a recession is necessary to once again balance demand with supply.  As demand begins to recover companies do not hire because they want to work off their inventory.  When demand starts to exceed supply companies initially look to press workers for more production and over-time hours begin to pile up.  As demand continues to grow companies have no option but to hire more workers to keep up.  Hence, economic recovery begins before hiring begins.

However, this is not a normal supply exceeding demand recession where too many cars were built and the fleet needs to age before substantial demand returns.  This depression is because of extremely tight credit markets that remain extremely tight.  The shadow banking system remains moribund and the Treasury reports bank lending is down.  It doesn’t matter if a consumer wants to buy a new car if they cannot get a loan.  Demand will not come back until access to affordable credit is restored.  So far it has not been restored.  Fannie Mae has tightened standards for mortgages and several major banks have tightened their own standards beyond what Fannie Mae is mandating.  Over half the country has a subprime credit score and no one is stepping up to increase subprime lending.  If demand doesn’t return the unemployed will stay that way for much longer than they anticipated.

Many workers who initially lose a job feel confident they will find work within a few weeks or months.  They rely on unemployment benefits and their 401(k) to sustain their living standards.  But as time goes by and job prospects remain grim people begin to cut spending and reduce their standard of living.  The U.S. economy is just now entering the phase where the huge ramp-up in unemployment that began a few months ago is leading to further reductions in consumer spending.  As long as consumer spending continues to slump unemployment will continue to rise.  This means further drops in employment from here will become a leading indicator of economic decline rather than a lagging indicator.  The only solution is to restore access to affordable credit to businesses and consumers.