By Rich Miller Sept. 28 (Bloomberg) — Full employment ain’t what it used to be. Economists since the mid-1990s have reckoned that full employment was equivalent to about a 5 percent unemployment rate, taking into account the time required to switch jobs. Now Nobel Prize winner Edmund Phelps and Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian say the fallout from the deepest recession in more than five decades is driving the so-called natural rate higher, perhaps to 7 percent. “We are in the midst of a large and protracted increase in both actual unemployment and its natural rate,” said El-Erian, 51, whose Newport, California-based company manages the world’s largest bond fund. Even with the economy growing, “it will take at least a couple of years” for joblessness to fall to 7 percent from 9.7 percent now. That may keep the federal budget deficit near a record $1.6 trillion into next year and might prevent the Federal Reserve from raising interest rates in 2010, said Bruce Kasman , chief economist at New York-based JPMorgan Chase & Co., the second- largest U.S. bank. Elevated unemployment will also “dampen the recovery in consumption and economic growth,” El-Erian said. President Barack Obama has highlighted job creation as the ultimate measure of the economy’s health, telling CNN television on Sept. 20 that it is “the single most important thing we can do.” By this measure, the U.S. is still coming up short, he added. That may hurt Obama’s Democratic Party in the November 2010 Congressional elections. Rising Unemployment Government data to be released Oct. 2 will probably show that unemployment rose to a 26-year high of 9.8 percent in September as companies pared payrolls by 180,000, according to the median forecast of economists surveyed by Bloomberg News. Obama, 48, has also pledged a sharp reduction in the budget deficit — a task that would be made more difficult if unemployment stays high, boosting government spending on people who are out of work and reducing tax revenue . The administration’s mid-term review forecasts a decline in the deficit to $917 billion in 2019 as unemployment drops to 5.2 percent. A rise in the natural rate — the level below which joblessness can’t fall without sparking inflation — would also create a dilemma for Federal Reserve Chairman Ben S. Bernanke and his central-bank colleagues. High unemployment argues for a loose monetary policy now; former Fed governor Lyle Gramley sees the central bank holding the federal-funds rate — the rate banks charge each other for overnight loans — near zero until early 2011. Later, there’s a risk Bernanke will ignite inflation if he tries to push the jobless rate down to the 5 percent equilibrium level that’s prevailed in the past. ‘Profound’ Implications “The implications over the next five to 10 years for fiscal and monetary policy are very, very profound” if the rate has risen, said Neal Soss , chief economist in New York for Credit Suisse Holdings USA Inc., a subsidiary of Zurich-based Credit Suisse Group AG , Switzerland’s second-biggest wealth manager. In that case, the best investment in the medium term might be to buy Treasury Inflation Protected Securities, said Soss, a former Fed official. TIPS of all maturities are headed for their fifth straight monthly gain as investors hedge against the potential for inflation, even as it has yet to materialize. The securities have gained 7.49 percent this year compared with a 2.65 percent decline for conventional U.S. government debt, according to the Merrill Lynch U.S. Treasury Inflation-Linked Master Index. Permanent Destruction Kasman ties an increase in the full-employment rate to the permanent destruction of hundreds of thousands of jobs in industries from housing to finance. Since the nadir of the last recession in November 2001, the U.S. has lost 839,000 jobs in the private sector, based on data from the Bureau of Labor Statistics — the first time that’s happened over the course of a business cycle since 1980-82. Manufacturing and construction were particularly hard hit. Permanent layoffs — for workers who don’t expect to ever regain the same job — hit a record 53.9 percent of the unemployed in August, according to the bureau. Some 33.3 percent of the jobless had been out of work for 27 weeks or longer last month, down from a record 33.8 percent in July. And at 59.2 percent, the share of Americans who are employed is at its lowest level in 25 years. “The labor market is showing signs of very considerable stress,” said Gramley, 82, a senior economic adviser for New York-based Soleil Securities . Job-Growth Engines Every state, the District of Columbia and Puerto Rico have seen unemployment rise during the recession. What’s more, the states that have been job-growth engines in the past — including California , Florida and Nevada — have been among the hardest hit as real-estate values plunged, said Lawrence Katz , a professor at Harvard University in Cambridge, Massachusetts. The 30 percent decline in house prices during the last three years also makes it hard for some Americans to seek work in another city or state, he said. About 26 percent of U.S. homes with a mortgage were worth less than the amount owed, according to a recent report by analysts Karen Weaver and Ying Shen in New York at Frankfurt-based Deutsche Bank AG , Germany’s biggest lender. Ultimately, as many as 48 percent of mortgages may be “underwater” as house prices fall further, they forecast. Katz identifies labor mobility as a key factor in reducing the natural rate of unemployment. Mobility fell last year to its lowest level since records began in 1948, according to the Census Bureau. The so-called national mover rate declined to 11.9 percent of the population in 2008 from 13.2 percent in 2007 as 35.2 million Americans one year or older changed residence. Deep Recession Mobility is likely to fall further this year in response to the deep recession, said Peter Francese , demographic-trends analyst for New York-based Ogilvy & Mather, which is owned by WPP Plc of London, the world’s largest advertising company. “It will plummet so close to zero you’ll be surprised,” said Francese, who founded American Demographics magazine. That will likely depress consumer spending, which historically accounts for about 70 percent of gross domestic product. “People who move spend a bundle, on draperies, furniture, rugs,” he said. A shift in the Beveridge curve is also signaling an increase in the natural, or non-accelerating inflation, rate of unemployment to between 6 percent and 7 percent, said JPMorgan Chase’s Kasman. Worker Skills Unlike the more popular Phillips curve, which compares unemployment to inflation, the Beveridge curve looks at job openings in relation to employment. A high level of both vacancies and unemployment suggests that workers lack the skills to fill the jobs available and that the natural rate, or NAIRU, is higher. The curve, developed by the late British economist William Beveridge, is more accurate at presaging changes in full employment than its Phillips counterpart, according to research by Brookings Institution Senior Fellow William Dickens that was presented at a Federal Reserve Bank of Boston conference last year. Many economists, including Gramley, don’t believe the natural rate has risen. Fed policy makers seem to be in that camp. They put the longer-run unemployment rate — a proxy for the NAIRU — at 4.8 percent to 5 percent, according to the minutes of their June 23-24 meeting. That may be too optimistic, said Phelps, 76, a professor at Columbia University in New York who won the Nobel Prize for Economics in 2006 for his theories on the interplay between inflation expectations and employment. “There’s a bit of whistling past the graveyard here,” he said. To contact the reporter on this story: Rich Miller in Washington rmiller28@bloomberg.net
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