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June 20, 19BO

7.8 -- 6.2

= 1,716,000

No profession has suffered as much of a credibility problem in recent years as the economics profession. Hand-wringing,
browfurrowing economists for several years
cautioned an unconcerned "spend-whileyou-have-it" public that a recession was just
around the corner. And quarter after quarter,
the corner remained the same distance away.
Even in late 1979, economists continued to
suggest that the recession would be a mild
one, because of such factors as the conservative inventory behavior of businessmen. For
example, the National Association of
Business Economists forecast last October
that the unemployment rate this year would
average 7.2 percent. But as we have seen, the
jobless rate jumped from 6.2 percent to 7.B
percent just between March and May of this
year-meaning (as the caption notes) a
l.7-million increase in the number of unemployed, on a seasonally-adjusted basis. And
once again, economists across the nation
have tried in vain to find an explanation for
their inability to forecast and explain major
econom ic events.
In their defense, economists argue that the
structure of the u.s. economy has changed in
many ways which are not well understoodone particular area being the labor market.
Aggregate inflation (the rise in the overall
price level) and the substantial increase in the
relative price of energy-intensive productive
inputs both have strongly affected the u.s.
labor market and changed our notion of what
constitutes fu II employment.

What's"full employment"?
Total employment increased very substantially, by 12.1 million, in the business expansion which began in the first quarter of 1975
and ended in the first quarter of this year.
Nonetheless, the unemployment rate never
fell below 5.7 percent in that entire period,
largely because of a parallel rise in the total
labor force. The same phenomenon has con-

tinued into 19BO.Of the increase in joblessness since January, 900,000 represent an
increase in the laborforce, while BOO,OOO
are
due to a decline in employment.
The civilian labor-force partiCipation rate
rose steadily through the 1 975-79 expansion
and even into the ensuing recession, reaching
64.2 percent this May, the highest ever. This
rise reflected an increase in women's participation rate, from 45.6 percent in 1974 to 51.0
percent in 1979, which contrastedyvith a
modest decline in men's participation rate.
Yet even with the sizable increase in the
number available for work, the number with
jobs hit record levels, as an unprecedented
(for peacetime) 59.3 percent ofthe adu It noninstitutional population held jobs in 1979.
Butto repeat, the jobless rate failed to decl i ne
below 5.7 percent throughout the prolonged
expansion, despite the vast expansion of
employment. Economists, and even some
policymakers, began to question why the
measured unemployment rate was so high in
a period when the economy was apparently
fully employed. And this raises a related
question: if we cannot measure accurately
the "full employment" unemployment rate,
how can we tell today what a high unemployment rate is?

Oil prices and labor demand
The strong employment gains of the past halfdecade cou Id be traced in part to the 1 97374 oil price shock, which reduced the relative
cost of labor inputs, particularly in manufacturing, and raised the cost of utilizing the
existing capital stock. The quadrupling of
OPEC oi I prices affected the U.S. economy in
two ways, through an "income effect" and
through a "substitution effect." Under the
income effect, the OPEC nations place a tax
on U.s. consumers which could only be partially recouped from OPEC purchases of U.S.
goods-that is they forced a change in the
U.S. "terms of trade." That loss could not

easily be circumvented by an expansion of
government spending or a speed-up in
money-supply growth. But under the substitution effect, labor at the margin became a
relatively lessexpensive input, because of the
rise in the cost of energy-intensive capital.
The rise in energy prices thus tended to increase the demand for labor, so that the
economy became more labor intensive.

rise in energy prices, they argued, the unemployment rate would have reached 10.3 percent in 1976 rather than the 7.7 -percent rate
actually experienced. The difference represented the substitution effect towards labor
that resulted from the first oil shock.
Real-wage behavior
The unexpected rise in U.S. labor demand in
the recent business expansion thus reflected a
decline in the real (inflation adjusted) wage
rate. Conversely, the major and prolonged
unemployment problems experienced by
other major industrial nations in that same
period reflected a rise in their real wage rate.

According to Edward A. Hudson and Dale W.
Jorgenson (NaturalResources Journal,1978),
the 1 973-74 rise in energy prices helped
account for the subsequent slow recovery in
business capital spending and very substantial increase in total employment. But for that

Between 1973 and 1975, real hourly compensation in U.S. manufacturing grew atonly
an O.B-percent average annual rate, compared with a 1 .S-percent average rise
between 1969 and 1 973.ln contrast, German
real wages continued to grow in excess of 7
percent after the first round of oil price increases, and real wages in the U. K. and
Canada rose at an even faster rate. Not surprisingly, then, the
experienced sharp
increases in manufacturing employment in
the 1 976-78 period, following a decline after
the initial price shock. Germany, in contrast,
experienced declines in manufacturing employment in every year from 1 974 to 1978,

u.s.

2

Moreover the increase in the ratio of labor per
unit of capital may mean also an increase in
the level of unemployment associated with a
fully-employed U.S. economy. Our recent
experience with double-digit inflation and
soaring interest rates may force us to revise
our estimates of what constitutes sustainable
full employment. It may also mean that
during the current recession the unemployment rate may be higher than previously for
the same reduction in real output growth.

wh i Ie the U. K. and Canada showed very little
employment growth. Real wage behavior accounted for the difference.
The behavior of employment in the nation's
current recession will again depend on the
behavior of real wages. The latest oil-price
hike and the double-digit inflation have
seriously reduced real spendable income,
and this will surely reduce aggregate demand. Yet if wage earners attempt to recoup
all of their losses with large wage bargaining
demands, they may not be as successful in
expanding employment as they were inthe
1975-79 period.

JosephBisignano

Any lessonslearned?
For policy purposes, it is necessary for us to
determine how much of the recent jump in
the unemployment rate-from 6.2 percent in
March to 7.8 percent in May-is due to increased energy prices, and how much to the
inflation-caused reduction in workers' incomes. The latest OPEC-generated rise in
energy prices certa i n Iy wi II have some u nemployment effects, similar to those caused by
the 1973-74 oil price rise. But we can also
anticipate a longer-run rise in total employment because of increased energy prices,
reflecting a substitution effect such as we experienced during the 1975-79 period.

3

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..

..
..
t'!UJoJ!It'J

BANKING DATA-TWELFTH FEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)

Loans (gross, adjusted) and investments*
Loans (gross, adjusted) - total#
Commercial and industrial
Real estate
Loans to individuals
Securities loans
U.s. Treasury securities*
Other securities*
Demand deposits - total #
Demand deposits - adjusted
Savings deposits - total
Time deposits - total#
Individuals, part. & corp.
(Large negotiable CD's)

WeeklyAverages
of Daily Figures
MemberBankReserve
Position
Excess Reserves (+ )/Deficiency (- )
Borrowings
Net free reserves (+ )/Net borrowed( - )

.. t'pt'/\aN .. 04t'PI
t'uozp V " t'>lst'IV

(\))

'l!ll!:) 'o:JsPUl!J:I Ul!S
lSL 'ON llW2Bd
(]I Vd
3!)\f lS Od 's'n
llVW SSV1:) lS}J1:I

Selected
Assets Liabilities
and
largeCommercial
Banl<s

..

Amount
Outstanding

6/4/80

Change from
year ago
Dollar
. Percent

Change
from

5/28/80

136,441
114,913
32,842
46,354
23,781
1,284
6,234
15,294
44,001
30,579
27,037
63,912
54,805
22,542

158
179
206
2
92
252
27
6
2,047
1,268
443
- 627
294
- 280
-

-

-

-

Weekended

Weekended

6/4/80

5/28/80

239
10
229

422
44
378

8,376
9,706
1,902
8,644
1,612
343
1,507
177
805
943
3,005
14,503
14,289
6,104

6.5
9.2
6.1
22.9
7.3
-21 .1
- 19.5
1.2
1.9
3.0
- 10.0
29.4
35.3
37.1

Comparable
year-ago period

20
73
54

* Excludes trading

account securities.
# Includes items not shown separately.

Editorial
comments beaddressed theeditor(WilliamBurke) to theauthor.... Free
may
to
or
copies this
of
andotherfederalReserve
publications beobtained calling writingthePublicInformation
can
by
or
Section,
Federal
Reserve
Bank SanFrancisco, Box7702,SanFrancisco
of
P.O.
94120.Phone
(415)544-2184.