16 April 2016

What explains changes in the labour participation rate?

Tens of papers or blog posts have been written in an attempt to explain why the labour participation rate in the US has been low after the recession. Among other factors, the aging of the workforce and disability have been advanced as explanations. However, an obvious reason seems to have been overlooked: low wage rates.

The graph below shows YoY changes in the civilian labour participation rate vs YoY changes in the real median household income between 1984 and 2014, the period for which data on the real median household income are available. It is clear that the two graphs follow roughly the same path.

In microeconomics the concept of economic profit is widely used. To entice a car company to enter the motorcycle market the mere existence of accounting profit in the new market is not sufficient. Profits in the motorcycle market, after considering all costs, must be higher than in the car market. Opportunity costs must be taken into account before making a decision.

It is the same in the labour market. At first sight it may seem odd that an individual should choose to earn no wages rather than some wages, however low. But when a household is regarded as the basic economic unit it makes sense. For instance, if childcare costs are higher than the wage for a new job, it makes economic sense for one parent to forego the job and take care of a child or children.

Category: Economics

05 April 2016

Who benefits from low interest rates?

In the Keynesian imagination lowering interest rates spurs companies to increase investment and output and consumers to plunk down money on big ticket items like cars and houses.

Japan has held interest rates close to zero levels for the better part of two and a half decades and the glorious recovery, which according to theory should have happened a long time ago, is nowhere in sight. Ditto for Europe and the US, though for shorter periods.

Could the theory be wrong and do low interest rates have quite the opposite effects? The graphs below are illuminating.

The first shows corporate profits after tax for the finance and insurance industry from 1998 to 2013. There is nothing surprising about it. For the greater part of the period it shows that when interest rates are lowered financial profits go up.

The next graph is more surprising. It shows that for the greater part of the period from 1954 to 2016, manufacturing employment rises with the Fed Funds Rate and falls when the Fed Funds Rate falls.

The final two graphs illustrate the same point.

These graphs go further to establish the point we made in a previous post: that raising interest rates from very low levels helps increase the supply of loans to the real economy by making investment in financial assets unprofitable. See Higher interest rates benefit the real economy.

Category: Economics

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