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MR. 'AttARnrct
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November 1980
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1
Supply-Side Economics: Its Role in Curing Inflation
6
"Fed Quotes"
8
Differences in Unemployment Incidence and Duration
Produce Differences in Unemployment Rates
16
Regulatory Briefs and Announcements
19
Now Available from the Federal Reserve
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This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)
Supply-Side Economics:
Its Role in Curing Inflation
Remarks by
Lyle E. Gramley, Member
Board of Governors of the Federal Reserve System
Washington, D.C.
before
Community Leaders in Seattle
Seattle, Washington
September 11, 1980
During the past several years, a profound revolution has been occurring in the thinking of many of
our nation's leaders concerning the proper role of
fiscal policy in helping to maintain the health of
our economy. For more than 30 years, our Government tried to use fiscal policy as a means of
smoothing out fluctuations in business activity.
Tax rates were cut, and expenditures increased,
when recessionary forces were pervasive. Growth
in expenditures was restrained-and on one occasion, tax rates were increased-to cool off
inflation.
Deep disillusionment has set in regarding the results of those efforts. As the prestigious Joint Economic Committee stated in its recent Midyear
Report on the economy, a review of the postwar
period shows that "government attempts to shortNovember t980/Voice
>
en the duration or reduce the intensity of recessions ... have been ineffective." Economic policy
for the future, the JEC argues, "must focus on the
supply side of the economy, on the long-term
capacity to produce...."
Supply-side economics is an exciting doctrine.
Its central tenets are not entirely new, but they
certainly are relevant. Our principal economic
problem today is inflation. A long-term strategy
is needed to deal with it.
Supply-side economics in fiscal policy is a logical complement to the way in which monetary
policy is currently being conducted. Last October
the Federal Reserve announced that it was changing its methods of implementing monetary policy
in ways that would improve its control over the
expansion of money and credit. Under this new
monetary policy strategy, prospects have been enhanced that growth of money and credit will slow
over the long run to rates that are consistent with
a moderation of inflation, and eventually a restoration of price stability. If fiscal and monetary
policies both aim at reducing inflation over the long
run, the prospects for success in this effort will
surely be greater.
How much help can we really expect from
supply-side economics in curing inflation? As I
think about that question, I cannot help but remember the enthusiasm with which economists of
my generation embraced the old fiscal doctrines
30 years ago. We spent a large part of our energy
elaborating the theory of aggregate demand management. as it was so often called, and testing its
conclusions against the facts. We tried our best
to make fiscal policy work in ways that would
1
reduce unemployment and idle capacity, keep the
economy operating close to its full-employment
potential, and yet avoid periods of excess demand
that create fresh inflationary forces.
In retrospect, our principal mistake was a failure to recognize the severe limitations of aggregate
demand management in an economy as complex
as ours. We tried to achieve results that simply
could not be realized.
The same danger exists now, I believe, with
supply-side economics. Steps to increase the potential output of our economy and to improve productivity can make a vital contribution to dealing
with inflation. However, unless we recognize the
limits of supply-side economics, and design our
economic policies accordingly, we could end up
making our inflation problem worse instead of
better.
What do we mean by supply-side economics?
Conceivably, a wide range of things could be included-energy policy, manpower training, Federal
support for higher education, and other programs
that might increase the growth of supply or enhance productivity. I propose to focus today on
three principal areas in which public discussion
of supply-side economics has centered in the past
several years: first, tax reductions on earned income-that is, on wages and salaries-to increase
incentives to work; second, tax incentives to businesses to increase the rate of capital formation
and thereby to improve productivity; and third,
tax reductions on investment income to encourage
a larger volume of private savings.
In discussing these three ways to increase aggregate supply, I do not propose to break any new
ground. My objective is merely to make some common-sense observations on the potential contribution of this fiscal policy approach to solving our
inflation problem.
Tax reductions on earned income
Tax reductions for wage and salary income, if
they contributed to the fight against inflation, would
certainly have the enthusiastic support of a large
number of our citizens. The average American
gives up about one-fifth of his income in the form
of direct tax payments to government; upperbracket rates are, of course, much higher-up to
70 percent for the Federal personal income tax.
Reducing these tax rates significantly might increase the willingness of individuals to work, and
2
it could do so in a variety of ways-by increasing
hours worked per day or per week, inducing
larger numbers of women to enter the labor force,
encouraging postponements of retirement age, or
making people willing to work harder. Is it possible
that the aggregate supply of labor, and hence the
output of goods and services, would rise substantially as a consequence of such tax reductions?
A bit of thought and introspection should raise
some doubts in our minds. Work hours tend to
be set by institutional arrangements as much as
by individual decisions. Objectives for working,
moreover, are complex and varied; many of us
work for reasons other than simply the income
we earn. Moreover, it is difficult to predict whether
a completely rational economic man would work
more or less if taxes were lowered. Lower rates
of taxation increase the take-home pay that can
be earned from an additional hour of work or a
second job, but they also make it possible to
attain any given standard of living with less work.
Studies of the effects of taxation on the available supply of labor both in the United States
and in other countries are numerous, but their
conclusions are ambiguous. Even in countries
where tax rates are considerably higher than in
the United States, such as the United Kingdom.
it is not clear that labor supply would increase if
taxes were lower. In a summary of the available
evidence two years ago. the Congressional Budget
Office concluded that labor supply probably would
increase if taxes on earned income in our country
were reduced. The effect, however, would be
small; total hours worked might increase by perhaps 1 to 3 percent for each 10-percent rise in
after-tax wages.
Reductions in taxes on wages and salaries stimulate demand as well as supply. Estimates of the
increase in demand that would result from such
tax reductions are also controversial. Nonetheless,
the available evidence indicates that the increase
in aggregate demand would be substantially larger
than the increase in aggregate supply, possibly 5
or 10 times as large, or maybe more.
Tax reductions on wage and salary incomes,
therefore, are not the most promising way to cure
inflation. Indeed, unless the effects on aggregate
demand were neutralized by raising other taxes or
cutting budgetary expenditures, such tax reductions-if undertaken on any substantial scalecould make our inflation problem worse.
This does not mean that our Government should
Federal Reserve Bank of Dallas
be insensitive to the burden of taxation that
Americans are bearing. Certainly, our chances for
healthy economic growth will be greatly enhanced
if the share of our national resources devoted to
Federal uses is reduced and the rate of taxation
is lowered. But it does suggest that the principal
contribution that supply-side economics can make
to fighting inflation lies elsewhere.
Investment incentives and productivity
Providing tax incentives for business investment
is another form of supply-side economics, one that
we know more about. On several previous occasions during the postwar period, incentives to
business capital formation have been increased
through accelerated depreciation or an investment
tax credit or a reduction in corporate profits tax
rates. We therefore have some basis on which to
judge their efficacy in stimulating capital formation
and productivity growth.
A number of proposals have been put forward
recently to stimulate investment through tax incentives. For example, in the Administration's recently announced fiscal program, allowable depreciation rates for new plant and equipment would
be increased by 40 percent, and the investment
tax credit would be liberalized somewhat. The
cost of these incentives, in terms of loss of Federal revenues, would initially be small but would
reach $25 billion per year by fiscal 1985. Corporate
tax payments in that fiscal year would be reduced
by approximately 17 percent as a result of the new
tax incentives.
It has been estimated that these investment incentives would increase the long-term growth rate
of productivity in our economy by about 0.4 percent per year-not right away but after several
years. Judging by studies of the effects of investment incentives introduced in the past, this is a
fairly generous estimate, but a reasonable one. To
put this amount of improvement in perspective,
we might note that productivity in the past five
years has been rising on average at about 1 to 1 1/2
percent a year. With an improvement of 0.4 percent, the trend would be up to 1 1/2 to 2 percent. If
improvements in productivity growth occurred for
other reasons as well, we might hope to regain
the 2 1/2-percent average annual rise that characterized the first two decades of the postwar period.
To put it another way, an improvement of 0.4
percent in annual productivity growth would lead,
November t98D/Voice
over the course of a generation, to an increase of
101/2 percent in the potential output of our economy. Such an increase would make possible a
welcome improvement in standards of living, in
addition to its potential contribution to moderating inflation.
Tax incentives to increase savings
Increased investment expenditures, however, must
be financed by increased savings. Otherwise, they,
too, may add to inflation rather than reduce it. Let
me turn next, therefore, to the third area of supplyside economics that I mentioned earlier: Are reductions in taxes on investment income an effective
way to increase savings?
Unfortunately, in this area, too, we do not know
as much as we need to know to justify bold action.
Like reductions in taxes on earned income, tax
reductions on investment income cut two ways.
By raising the after-tax earning power of every
dollar saved, they increase the benefit to the consumer of postponing purchases today in order to
increase buying power tomorrow. But because of
that, they reduce the amount that a consumer has
to save to assure his ability to achieve a given
living standard later on.
No one knows for sure which edge of the blade
cuts more deeply. Some studies have concluded
that if our tax structure were changed in ways that
reduced the taxation of investment income, and
raised the level of taxes on other forms of income,
there would be no effect at all on private saving.
Others suggest beneficial effects on private savings.
This state of affairs should not prevent us from
experimenting cautiously with changes in the tax
structure that might encourage more saving. In
light of the uncertainties, however, it is hard to
imagine that tax incentives to foster savings call
play more than a minor role in our battle against
inflation, at least in the relatively near future.
Fortunately, there is a surer way of increasing
the amount of savings available to finance a higher
rate of business investment. It is an old-fashioned
method, and one that has not been used much in
the past two decades. It is to reduce the deficit
in the Federal budget through restraint on Federal
spending as rapidly as economic conditions warrant, and eventually eliminate it altogether. Surpluses in the Federal budget, used to retire debt.
would return funds to financial markets that could
finance the additional business investment needed
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to improve productivity growth. That is also the
way .t~ increase the prospects that improved prodUCtiVIty growth will actually result in lower inflation. Let me turn to that issue next.
Productivity and inflation
Increasing productivity growth through tax incentives for business investment appears to me to be
the most promising route for moderating inflation
through supply-side economics. But will it work?
And how weIl?
Unfortunately, there is no guarantee that improved productivity will automatically reduce
inflation. Indeed, among the major industrial nations of the world, rates of inflation during recent
years have not been closely correlated with rates
of productivity increase. From 1974 to 1979, for
example, manufacturing productivity rose faster
in France than in any other major industrial country. Yet, the rate of inflation in France during that
period was higher than that for the United States
and Canada, and far above that for Japan and West
Germany.
How much an improvement in productivity contributes to reducing inflation depends on the responses of businesses and workers. If businesses
do not, or cannot, increase their profit margins,
the slower rise in costs that higher productivity
brings will show up in smaller increases in prices.
If workers then accept smaller wage increases because inflation is moderating, costs would rise still
more slowly and the inflation rate would come
down further. The inflation rate might ultimately
decline by two to three times as much as the initial increase in productivity.
The potential reduction in inflation made possible by a higher rate of advance in productivity
will be realized, however, only if conditions in
labor and product markets promote the necessary
response in wages and prices. Product markets
must be sufficiently competitive so that businesses
are motivated to pass reductions in their costs
4
through to lower prices. Markets for labor must
be sufficiently slack so that workers are encouraged to accept smaller wage rate increases as the
rise in prices moderates. That is why prudent monetary and budgetary policies-policies that aim
for slower growth of money and credit and for
movements of the Federal budget toward surplusare a necessary adjunct to supply-side economics.
Unless these two work hand in hand, the promise
that supply-side economics holds for reducing inflation could easily be lost.
Let me try to pull the threads of my argument
together. Tax incentives to stimulate business capital spending appear to be the surest way of increasing our aggregate capacity to produce. At a
cost of about $25 billion annually by 1985, in terms
of revenue loss to the Treasury, we might reasonably expect productivity growth to increase by
about 0.4 percent per year. Under favorable economic conditions the inflation rate might be
brought down by about 1 percentage point, or
perhaps a little more, through this means. These
are, I believe, realistic estimates of the costs and
benefits of going the route of supply-side economics.
If the cost is that high, you may ask, is it worth
it? I would respond: What better alternatives are
there? Certainly, it is preferable to use tax policy
to increase productivity and our capacity to produce than to try to squeeze out inflation by relying
solely on highly restrictive fiscal and monetary
policies, with the inevitable losses of jobs and
real output that would be entailed.
Supply-side economics is obviously no cure-all
for inflation. But the problem of inflation is so
intractable that no single measure to deal with
it will suffice. Our only hope for making substantial progress against inflation over the next several
years lies in keeping the fight against inflation at
the forefront of every economic policy decision.
If we recognize its limitations as well as its
strengths. supply-side economics can play an extremely useful role in that endeavor.
Federal Reserve Bank of Dallas
New member banks
First City Bank-North Belt, N.A., Houston, Texas, a newly organized institution located in the territory served by the Houston Branch of the Federal
Reserve Bank of Dallas, opened for business October 1, 1980, as a member
of the Federal Reserve System. The new member bank opened with capital
of $750,000 and surplus of $750,000. The officers are: Edwin Finn, Chairman
of the Board; Norma Galloway, President; Vernon Pool, Senior Vice President and Cashier; James Kerby, Vice President; and Josephine Cisneros,
Administrative Officer.
Alvin Community Bank, N.A., Alvin, Texa:>, a newly organized institution
located in the territory served by the Houston Branch of the Federal Reserve
Bank of Dallas, opened for business October 7, 1980, as a member of the
Federal Reserve System. The new member bank opened with capital of
$750,000 and surplus of $750,000. The officers are: J. W. Lander, Jr., Chairman of the Board; Davis L. Llenos, Vice Chairman of the Board; B. J. Corley.
Jr., President; and Chas. A. Thomas, Vice President and Cashier.
American National Bank of Plano, Plano, Texas, a newly organized institution located in the territory served by the Head Office of the Federal Reserve
Bank of Dallas, opened for business October 15, 1980, as a member of the
Federal Reserve System. The new member bank opened with capital of
$1,000,000 and surplus of $1,000,000. The officers are: Jerry D. Stiles, Chairman of the Board; John A. Bryant, President; Lynn Barton, Executive Vice
President and Cashier; and Connie 1. Clark, Assistant Vice President.
November 1980/Voice
5
•• Ped Quotes ~~
Brief Excerpts from Recent Federal Reserve Speeches, Statements, Publications, Etc.
"When American bankers look back upon the decade of the 1970's, they can add
up a number of impressive achievements. American banks have innovated vigorously,
both abroad and at home. Abroad they have played a pioneering role in the financing
of developing countries and particularly in the recycling of OPEC funds. At home
new techniques of lending, of raising funds, and particularly of serving the consumer
have been developed. Through the bank holding company device. banks have been
able to break out of their geographical confinement at least in limited fields such as
consumer and mortgage financing. They overcame the difficulties of 1974-75 which
incidentally provided a positive test of the effectiveness of American institutional
arrangements for dealing with a major bank failure.
"At the same time, American banks have experienced trends that are less
constructive and call for careful analysis. Large American banks have embarked on a
program of heavy lending to developing countries. which carries them into an only
partially charted risk area. As a group. these banks nevertheless have fallen behind
in the race against foreign competitors for market shares worldwide. Domestically,
the share of banks in the total supply of credit has diminished. The dependence of
particularly the largest banks on purchased funds of a volatile character has increased.
The value assigned to the largest banks by the stock market has fallen to levels at
which it becomes very difficult for them to issue new stock. Meanwhile their capital
has not kept up with the rise in their assets.
"These generalizations, to be sure, apply to different U.S. banks in very different
degree. It is principally the money center banks that have experienced the problems
just noted, and in lesser degree the large regional banks. Small local banks have
been affected far less.
"These differences are crucial to an evaluation of the American banking scene.
Local banks, with assets of up to perhaps $100 million. typically have had good
earnings, of the order of one percent on assets or more. compared to one-half to
three-quarters of one percent for the money center banks. Their capital averages 8
percent of assets, contrasted with 4 percent or less for the money center banks. Their
stock typically sells at a sizable premium over book value. contrasted with a discount
from book value for many money center banks that has begun to be corrected in a
few cases only recently. Considerable regional differences are observable in the
experience of small banks during the 1970's, and it is conceivable that increasing
competition. especially with thrift institutions and perhaps with larger banks more
aggressively deploying innovative techniques, may change the picture for small
banks during the 1980's."
Henry C. WalIich, Member, Board of Governors of the
Federal Reserve System (At the Roundtable on Credit
Systems in the 1970's, Perugia, Italy, September 5-7,
1980)
6
Federal Reserve Bank of Dallas
"In this regard, the Board continues to have strong reservations about the use of
the discount rate for indexing permissible loan rates because, among other reasons,
it imposes what is a short-term rate on markets that usually involve long-term lending,
and movements among short-term and long-term rates often diverge substantially.
In addition, we feel it is unwise to single out a tool of monetary policy for a purposesuch as indexing-that is not directly policy related. We therefore again urge Congress
to find a more appropriate formulation."
Frederick H. Schultz, Vice Chairman, Board of
Governors of the Federal Reserve System (Before
the Small Business Oversight Subcommittee, U.S.
House of Representatives, September 23, 1980)
"The United States probably has become the country where a given rate of
inflation does more damage than anywhere else.
"We have allowed inflation to have its full impact on saving and on investment,
outside the real estate sector. We have allowed inflation grossly to dilute business
profits, to the extent where many of the dividends paid are in effect liquidating
dividends that ought to be nontaxable to the recipient if inflation-adjusted accounting
were permitted for tax purposes. Some areas of the economy have in effect been
indexed against inflation, such as wages, interest rates, the government sector, and
single-family homes. Other areas, especially saving and business profits, have not
had this kind of protection. The result has been a calamitous drop in productivity
gains. We might be better off if we recognized the damage, allowed realistic inflation
accounting, and, to the extent that we fail to reduce inflation, adjust our tax and
financial system to minimize the damage."
"Because we are dealing principally with a structural rather than a cyclical
problem, our measures should be shaped to that situation. Tax reform is urgently
needed. But a premature tax cut that drives up the budget deficit and interest rates
without reducing the size of the public sector can be very damaging. We would be
moving toward a fiscal/monetary mix of easy budgets and tight money, exactly the
opposite of what our economy needs if productivity is to recover."
"We seem to have difficulty realizing that interest rates must be evaluated not
only after inflation, but after taxes. On reasonable calculations, it becomes evident
that at the short-term end interest rates after inflation and taxes have been negative
60 percent of the time since 1960 and at the long-term end 65 percent of the time.
Negative real interest rates both distort and overstimulate the economy. Countries
that have successfully dealt with inflation generally have managed to avoid both
mistakes. A stable rate of growth of the money supply, which in effect leaves the
determination of interest rates to the market, offers the best prospect that negative
real rates will be avoided most of the time, although some fluctuations in nominal
interest rates probably are unavoidable.
"Positive real interest rates look high in nominal terms and may have some
tendency to slow economic expansion in the short run. This is the obverse of the
familiar proposition that one can always, in the short run, stimulate the economy
by making money a little cheaper and printing more of it. But in the longer run,
negative real interest rates are a drag on the economy, just as past efforts to keep
stimulating the economy have turned out to be. Expansion promoted by negative
real interest rates would be artificial and short-lived."
Henry C. WalIich, Member, Board of Governors of the
Federal Reserve System (At the 1981 Business Outlook
Conference sponsored by The Conference Board,
New York, New York, September 25, 1980)
November 1980/Voice
7
Differences in Unemployment
Incidence and Duration
Produce Differences
in UnemploylDent Rates
By James E. Pearce
Few economic statistics receive as much attention
as the aggregate unemployment rate. Policymakers
follow it to monitor utilization of the nation's productive capacity, and many forecasters find it
helpful in predicting changes in the rate of inflation. Unfortunately, the emphasis on these functions has somewhat overshadowed the information
the unemployment rate provides about the prospects facing the individual jobholder. The changes
in economic activity that produce most of the
variation in unemployment affect the working
population in many ways, but the principal concerns of the typical worker include the chance
that he might become unemployed in the near future and the amount of time he can expect to remain out of work if that should occur.
This article examines the relationship between
the unemployment rate and the incidence and
duration of unemployment. The measure of incidence used is the percentage of workers unemployed at least one week during the year in
question. The measure of duration is the mean
number of weeks of unemployment these workers
accumulated in all spells of unemployment that
year. The article briefly covers the behavior of
incidence and duration over time for the entire labor force and also identifies the source of the high
B
and variable unemployment rates characteristic of
particular occupation and demographic groups.
The evidence indicates that the increases in unemployment that occur during economic recessions
reflect rises in both incidence and duration in
about equal shares, but the rising trend in the
natural rate of unemployment appears to be due
primarily to an increase in the percentage of workers who become unemployed. Differences in the
unemployment rates of various labor force groups
are, in most cases, due to differences in incidence.
The difference in unemployment for blacks and
whites is an exception to this rule, however, as
greater duration contributes heavily to the higher
unemployed rate observed for blacks.
Variation over time
This investigation covers the behavior of incidence
and duration between 1967 and 1977. The changes
in unemployment during this period were due to
a rising trend in the equilibrium, or "natural,"
unemployment rate as well as to variation in the
overall level of economic activity. The macroeconomic disturbances included the economic expansion that accompanied expenditures for the Vietnam War and the Great Society program, the mild
Federal Reserve Bank of Dallas
Cyclical increases in unemployment of full-year workers
reflect jumps in incidence and duration
Duration of unemployment'
Percent
distribution of
unemployed workers
Percent of
labor force
unemployed
Unem·
ployment
rate l
At
least
1 week
Over
26
weeks
Mean
(Weeks)
lto
4
weeks
Over
26
weeks
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977 '"
2.2
1.9
2.1
3.3
3.9
3.5
2.9
3.6
5.7
5.2
4.6
8.0
7.3
8.0
10.9
11.7
10.6
9.7
11.8
15.5
14.8
13.6
1.0
.8
1.0
1.7
2.4
2.1
1.5
1.9
3.7
3.4
2.8
14.0
13.5
13.5
15.5
17.5
17.0
15.5
15.5
19.0
18.0
17.0
24.0
27.0
27.0
19.0
17.0
18.5
20.5
19.0
14.5
15.5
17.0
12.5
11.5
12.5
16.0
20.5
19.5
15.5
16.5
24.0
23.0
20.5
Mean ...
3.5
11.1
2.0
16.0
20.0
17.5
Year
1 (Weeks unemployed/weeks in labor force) x 100.
2. Figures rounded to the nearest 0.5.
SOURCES: U S. Bureau of the Census.
Federal Reserve Bank of Dallas.
recession of 1970-71 that accompanied the subsequent reduction in military spending, and the
more severe recession of 1974-75 that followed
the sharp rise in the price of oil in late 1973.
The data in the accompanying table and charts
are based on work experience information from
the Current Population Survey conducted each
March by the U.S. Bureau of the Census. The
analysis is confined to unemployment of workers
who remain in the labor force the year round.
(Other studies have shown that the unemployment
data for part-year workers contain weaknesses and
ambiguities that complicate analysis of their labor
force activity.) The unemployment series for fullyear workers lies a considerable distance below
the unemployment series for the entire labor force.
The difference reflects the greater stability of
year-round workers, who change jobs much less
frequently than people who withdraw from the
labor force part of the year. A more detailed description of the data and the considerations dictating the choice of the sample and the estimators is
provided in the Appendix.
The recessions caused pronounced increases in
both dimensions of unemployment. Incidence-the
percentage of workers unemployed one or more
weeks during the year-rose approximately 50
November 1980/Voice
percent in the course of peak-to-trough movements
in economic activity over the 1969-71 and 1973-75
periods. Duration-the mean accumulation of unemployment-rose about one month in each case,
as the incidence of long-term unemployment,
shown in the third column in the table, increased
about 150 percent.
The estimates suggest that changes in incidence
and duration contributed about equally to the increases in unemployment in the recessions. If
mean duration had remained at its 1969 value of
13.5 weeks in the next two years. the rise in the
percentage of people becoming unemployed that
occurred through 1971 would have added about 1
percentage point to the unemployment rate. A
similar calculation indicates the rise in incidence
between 1973 and 1975 added about 1.5 percentage
points to unemployment.
These figures imply that wider incidence accounted for somewhat more than half of the rise
in the unemployment rate in the two recessions.
The work experience survey's truncation of spells
that overlap calendar years, discussed in the Appendix, probably causes the understatement of
mean duration to be greater in periods when more
spells of unemployment are long, however. Consequently, changes in incidence alone likely account
9
CHART 1
High incidence is responsible
for the high unemployment
of construction and auto workers •••
UNEMPLOYMENT RATE
15 PERCENT OF FULL·YEAR LABOR FORCE-
10 -
CONSTRUCTION AND
AUTOMOBILE WORKERS
5OTHER WORKERS
0--------------INCIDENCE
for no more than half of the cyclical changes in
the unemployment rate, and their actual contribution may even be slightly smaller than 50 percent.
The composition of the secular increase in unemployment differs markedly from the composition
of cyclical variation. Comparisons of incidence and
duration for years in which the business cycle was
in similar phases-such as 1970 and 1974 (recession
years in which unemployment was rising rapidly)
and 1972 and 1977 (years when the economy was
recovering from recession)-suggest that the rising
trend in the unemployment rate is primarily attributable to the upward drift in the incidence of unemployment. Changes in aggregate economic ac-
One out of nine full-year workers would
spend at least one week on layoff or
looking for another job in a year in which
full utilization of resources prevailed. The
average amount of time spent unemployed
would be about four months.
40 PERCENT UNEMPLOYED AT LEAST 1 WEEK-
30-
20 OTHER WORKERS
10-
0--------------DURATION
20 WEEKS UNEMPLOYED ----~---
10-
CONSTRUCTION AND
AUTOMOBILE WORKERS
o -r-.,..-r-"'T"'....,I~.,...--,-.,._"""T-T"'""..,.
'67
'69
'71
'73
SOURCES: U.S. Bureau of the Census.
Federal Reserve Bank of Dallas.
10
'75
'77
tivity appear to account for most of the variation
in duration. The brief sample period and the dominance of short-run fluctuations limit the precision
of any conclusions that may be drawn on this matter, but changes in duration appear to have contributed much less to the recent trend in unemployment than they have to cyclical changes.
The instability of the unemployment rate in this
period makes it difficult to determine a set of unemployment figures that is consistent with full
utilization of resources. but simple averages of the
series in the table should provide adequate approximations for discussion. The mean of incidence
indicates that one out of nine full-year workers
would spend at least one week on layoff or looking for another job in a year in which full utilization prevailed. The average amount of time spent
unemployed would be about four months, but the
mean duration for the few full-year workers who
accumulate more than six months of unemployment
would be about nine months. Although the number
of people in this group is small, its members account for about 40 percent of the total number of
weeks of unemployment and, thus. play an important role in the determination of the unemployment rate.
Federal Reserve Bank of Dallas
Accounting for high unemployment
of particular groups
The above statistics may serve as useful guides to
the job market conditions facing most workers,
but the aggregate series do not describe the experiences of members of several atypical groups.
The distinctive behavior of unemployment statistics for subgroups of the labor force that characteristically exhibit high and variable unemployment
rates has always captured the attention of analysts, and the employment of workers in these
groups has often been a major objective of economic policy. The charts here illustrate how the
disparities in incidence and duration lead to higher
unemployment rates for construction and automobile workers, young workers, and blacks.
Workers in the construction industry and motor
vehicle manufacturing industry have relatively
high average unemployment rates each year because the demand for their services changes from
month to month. In addition, purchases of homes
and new cars are sensitive to changes in interest
rates, so the unemployment of these workers varies
considerably from year to year. The unemployment rate for construction and auto workers was
more than twice the unemployment rate for fullyear workers in others industries throughout the
1957-77 period. Only in 1968 did the constructionauto unemployment rate fall below 5 percenta level that the rate for other workers reached
only in 1975.
The entire difference between these unemployment rates was due to higher incidence for workers
in the construction and auto industries. Even in
the late 1960's, the years of strongest demand,
about 20 percent of the workers in these industries
were unemployed at least one week; in the 1975-77
period, incidence for construction and auto workers was above or near 30 percent. Unemployment
incidence for other workers remained below 10
percent in all years except those associated with
economic recession. The difference in unemployment duration for the two groups remained small
throughout the period covered by the data; the
largest disparity was less than two weeks.
The unemployment series for young adults also
lies above the aggregate unemployment series and
exhibits greater cyclical variation. More young
people are in transitional phases of their careers,
so young workers account for a disproportionate
number of job changes. which often involve interludes of unemployment. Since the typical young
November t910/Voice
CHART 2
•.. and for the high unemployment
rate of young workers ...
UNEMPLOYMENT RATE
15 PERCENT OF FULL·YEAR LABOR FORCE-
10-
5WORKERS 25 AND OVER
0---------------INCIDENCE
40 PERCENT UNEMPLOYED AT LEAST 1 WEEK-
30-
20-
10 WORKERS 25 AND OVER
0-------------DURATION
20 WEEKS UNEMPLOYED
-----=---WORKERS 20 TO 24
YEARS OF AGE
10 -
WORKERS
25 AND OVER
o -_-,...-r-""'T"'--.I~"'T"".....-__r_"""'T-T'""_r'67
'69
'71
'73
'75
'77
SOURCES: U.S. Bureau of the Census.
Federal Reserve Bank of Dallas.
11
worker has accumulated little seniority, his employment is particularly susceptible to a decline
in economic activity.
The data indicate that the unemployment rate
for workers 20 to 24 years of age was about twice
the unemployment rate for full-year workers older
than 24, and the disparity widened during the
years when unemployment was rising. Here again,
a difference in incidence accounts for the entire
difference in unemployment rates, as the durations
for younger workers lie slightly below those of
the over-25 group.
CHART 3
.•. but greater duration contributes
to the high unemployment of blacks
UNEMPLOYMENT RATE
15 PERCENT OF FULL·YEAR LABOR FORCE-
10 -
The proportion of blacks experiencing
some unemployment in a given year was
about 4 to 5 percentage points higher, and
durations for blacks were generally two to
three weeks longer than for whites.
BLACKS
5-
0--------------INCIDENCE
In the final comparison, the data reveal that
unemployment has been higher for blacks than for
whites. Workers with relatively poor educations
and little training and those employed in low-wage
occupations generally have high unemployment
rates, and this description fits more blacks than
whites. Discrimination may also have contributed
to black unemployment. The disparity of 2 to 3 percentage points between the unemployment rate for
blacks and that for whites reflects differences in
both incidence and duration. The proportion of
blacks experiencing some unemployment in a
given year was about 4 to 5 percentage points
higher, and durations for blacks were generally two
to three weeks longer.
A widely held proposition maintains that unemployment of blacks is more sensitive to changes
in economic activity than unemployment of whites.
This claim is difficult to verify in the unemployment statistics for full-year workers because cyclical and secular changes in the difference between
unemployment of blacks and whites cannot be
distinguished easily. If the unemployment rate for
blacks were more volatile than the unemployment
rate for whites, the difference between the two
should rise in recessions and fall in recoveries.
Actually, the series diverged during years when
unemployment increased, but they displayed little
tendency to converge when the pace of economic
12
40 PERCENT UNEMPLOYED AT LEAST 1 WEEK-
30BLACKS
20 -
10 -
0----------------DURATION
30 WEEKS UNEMPLOYED - - - - - - - BLACKS
20_
/'
-
~
:
WHITES
10 -,.......,..-,r-...--,-..,...--rl-,---r-r--,-'67
'69
'71
'73
'75
77
SOURCES: U.S. Bureau of the Census.
Federal Reserve Bank of Dallas.
Federal Reserve Bank of Dallas
activity revived. Consequently, while the gap between the unemployment rates for blacks and
whites widened over the 1967-77 period, the source
of the divergence cannot be classified as cyclical
or secular from the data here. Both incidence and
duration followed this pattern, so the behavior of
the separate unemployment dimensions contributes no additional information that would help
make this distinction.
Concluding remarks
Accounts in the press often refer to the unemployed as people who cannot find jobs, implying
that episodes of unemployment typically continue
indefinitely and impose extreme hardship on affected households. The evidence in this article suggests that the unemployed are better described ns
those who have not yet found jobs. For most
people, unemployment in a nonrecession environment is a disruptive but not catastrophic experience. In an average year, five out of six yearround workers who spend some time on layoff or
looking for work accumulate less than six months
of unemployment; the average accumulation for
this group is about three months.
A higher percentage of workers 20 to 24
years old have interruptions in their employment, but there is no indication that
they have more difficulty acquiring new
jobs.
The evidence also suggests that the current
limitations on the number of weeks anyone individual may be eligible for unemployment insurance
benefits are about right. Most states allow receipt
of benefits for a maximum of 26 weeks except in
periods of high unemployment, when the eligible
unemployed may draw benefits up to 39 weeks.
These constraints would cover the total annual
accumulation of unemployment for over 80 percent of those who become unemployed. The case
for extending the maximum weeks of eligibility to
52 or more, as was done in the 1974-75 recession,
is weak.
The importance of incidence in accounting for
most of the differences in the behavior of unemployment rates for different labor force groups has
some interesting implications. High unemployment
of young adults has caused considerable concern
among some observers, who have regarded it as
a manifestation of the inability of young workers
to find employment. The evidence here indicates
that a higher percentage of workers 20 to 24 years
old have interruptions in their employment, but
there is no indication that they have more difficulty
acquiring new jobs.
A similar conclusion does not hold in the case
of high unemployment of blacks. Greater duration
contributed substantially to the higher black unemployment rates from 1967 to 1977, and the difference between mean duration for blacks and that
for whites widened over the period. This accounted
for much of the divergence in the black and white
unemployment series, which must be regarded as
a conspicuous failure of U.S. economic policy in
the past decade.
Finally, the consequences of analyzing data for
full-year workers only must be noted. People in
the labor force the year round account for only
half of all unemployment. Thus, the behavior of
some labor force series cannot be explained by
examining the experience of members of this group.
The unemployment of teenagers, particularly black
teenagers, is perhaps the most obvious example.
On the other hand, the behavior of the unemployment series examined above has closely paralleled
the behavior of the corresponding official unemployment statistics, which are computed using
samples that include part-year workers. Therefore,
most of the conclusions reached from analysis of
the limited sample can probably be safely extended to the more general case.
Appendix
The data used to estimate unemployment
incidence and duration were obtained from
the March Current Population Surveys for
1968 through 1978. The Current Population
November 1980/Voice
Survey (CPS) is a household survey conducted monthly by the U.S. Bureau of the
Census and is the source of the data the Department of Labor uses in computing official
13
Table 1
COMPOSITION OF FULL·YEAR LABOR FORCE
Percent distribution
of ages
Year
1967
1972
1977
20
to
24
25
to
54
55
and
over
12.4
15.6
17.1
66.4
65.0
65.8
21.2
19.4
17.1
Percent of
labor lorce
Females
Blacks
34.3
35.7
38.3
10.8
10.0
10.4
SOURCES: U.S. Bureau of the census.
Federal Reserve Bank of Dallas.
unemployment statistics. The March interview contains some supplemental questions
about the respondents' labor force activity
in the previous year, including the number
of weeks worked and weeks unemployed.
The work experience interview has two
weaknesses that may bias the estimates. First,
people who work 50 or 51 weeks are not
asked if they were unemployed during the
survey period. This may preclude the
reporting of many one- and two-week spells
and, if it does, will make unemployment
appear more protracted than is actually the
case. Second, the survey questions refer to
a specific year, so the amount of unemployment experienced by people with spells
beginning in one calendar year and ending
in another will be understated. The biases
from these two sources will offset one another,
but which dominates is not known. The
resulting error is believed to be insignificant,
but the situation should be kept in mind when
reviewing the findings.
A source of possibly serious error is the
questionable reliability of information obtained in response to questions that require
14
recalling details about activities as far in
the past as 15 months. Although the accuracy
of the data is difficult to verify, the consistency of work experience data with official
unemployment statistics has been examined.
This research indicates that for people who
are routinely in the labor force, the unemployment reported in the work experience
interview is consistent with official unemployment statistics.! People who divide their time
between work for pay and work in the home
or work in school report less unemployment
in the work experience interview than in the
monthly CPS interview. In order to make the
estimates here more consistent with official
statistics, the sample was restricted to
workers who were at least 20 at the time of
the March CPS interview and reported
spending at least 40 weeks of the previous
year in the labor force.
1. Richard D. Morgenstern and Nancy S. Barrett, "The
Retrospective Bias in Unemployment Reporting by
Sex, Race and Age," Journal of the American Statistical Association 69 (June 1974) :355-57.
Federal Reserve Bank of Dallas
Table 2
UNEMPLOYMENT RATES FOR MALES 25 TO 54
Seriea
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
Official unemployment
rate ' ...•..........
1.9
1.7
1.6
2.8
3.5
3.1
2.5
3.1
5.7
4.9
4.3
Work experience
estimate' .........
1.9
1.6
1.8
2.8
3.2
2.7
2.2
3.0
4.7
4.3
3.6
1. Percent of civilien labor force.
2. Mean of (weeks unemployed/weeks in labor force) x 100.
SOURCES: U.S. Bureau of the Census.
U.S. Department of Labor.
Federal Reserve Benk of Dallas.
The tables show characteristics of the
sample. Table 1 displays demographic information. The most notable points there are
the widely publicized rising trends in the
ratio of young workers to older workers and
the ratio of women to men. Table 2 contains
the official annual average unemployment
rate for prime-age males and the comparable
statistic computed from the work experience
data, which is the annual percentage of weeks
in the labor force that male workers in the
25-54 age group spent unemployed. The two
series are close to one another in most of the
years, but they diverge somewhat during the
recessions. Still, their consistency is sufficient for the sample data to be regarded
acceptable for some broad inferences about
the composition of changes in the official
unemployment rate.
The duration estimates reported here are
considerably larger than those reported in
previous research. Several factors may account for the discrepancy. First, most analysts estimate the mean duration of individual
spells of unemployment, but the figures here
are mean annual accumulations of weeks of
November t980/Voice
unemployment per unemployed worker. The
two estimates will differ if some workers
have more than one spell per year. Second,
the sample excludes seasonal workers, who
are more likely to abbreviate their episodes
of unemployment by dropping out of the
labor force. Recent research suggests that
annual accumulation may be a more appropriate measure of duration than the lengths
of individual spells because multiple spells
per worker and spells terminated via withdrawal are both common. 2
2. For example, Stephen T. Marston, "Employment
Instability and High Unemployment Rates," Brookings Papers on Economic Activity, 1976. no. 1, pp.
169-203, and Kim B. Clark and Lawrence H. Summers,
"Labor Market Dynamics and Unemployment: A Reconsideration," Brookings Papers on Economic Activity, 1979, no. 1, pp. 13-60, report high rates of labor
force withdrawal for unemployed teenagers and
adult women. George A. Akerlof and Brian G. M.
Main, "Unemployment Spells and Unemployment
Experience," Special Studies Papers, no. 123 (Washington, D.C.: Board of Governors of the Federal Reserve System, Division of Research and Statistics,
October 23, 1978), discuss the problem of recurrent
spells.
15
GRegulatory GJ3riefs
andc.f/nnouncements
NOW Accounts:
Eligible Holders,
Advertising Policy,
Ceiling Rate Announced
The Depository Institutions Deregulation and
Monetary Control Act of 1980, enacted March 31,
authorizes depository institutions [except credit
unions) nationwide to offer interest-bearing
accounts upon which transferable or negotiable
orders of withdrawal may be drawn. Depository
institutions are authorized to make NOW account
services available beginning December 31. 1980.
Under the act, NOW accounts are available only
to individuals and to qualifying organizations that
meet two separate tests of eligibility. To be
eligible, an organization must be operated primarily for religious, philanthropic, charitable,
educational, or other similar purposes and must
not be operated for profit. The categories of depositors designated by the Federal Reserve Board
as eligible to maintain NOW accounts at member
banks are:
1. Individuals
2. Sole proprietors
3. Husband and wife operating unincorporated
businesses
4. Local housing authority
5. Residential tenants' security deposits
6. Independent school districts
7. Redevelopment authority
8. Escrow funds [provided the entire beneficial
interest is held by individuals or qualifying
organizations)
9. Labor unions
10. Trust and other fiduciary accounts [provided
the entire beneficial interest is held by individuals
or qualifying organizations)
11. Pension funds
12. Trade associations
The Board has also issued a list of depositors
generally found ineligible to maintain NOW
16
accounts at member banks. These depositors
include:
1. Realty or real estate investment trusts
2. Credit unions
3. Blue Cross/Blue Shield and similar plans
4. Military exchanges and purchasing
cooperatives
5. Hospital districts
6. State and local governmental units [except
those qualifying above)
7. Partnerships operated for profit
8. Professional corporations
9. Business corporations
10. Trustees in bankruptcy [unless the entire
beneficial interest in the bankrupt's funds is held
by individuals or qualifying organizations)
11. Political parties or campaign committees
The Board has adopted a policy statement concerning the advertising of NOW accounts. The
policy states that institutions may engage in
advertising and promotional programs prior to
December 31 and may offer accounts that will be
converted to NOW accounts on that date. but such
programs must accurately describe the nature of
NOW account services. In promoting checking
accounts that will be converted to NOW's, it
should be made clear that interest cannot be paid
on the accounts before December 31. Any terms
or conditions to be imposed on the accounts should
also be disclosed in the promotion or
advertisement.
The Depository Institutions Deregulation Committee has established an interest rate ceiling of
5 1/4 percent on NOW accounts, effective December 31,1980, at all types of depository institutions
authorized to offer such accounts. These include
commercial banks, mutual savings banks, and
savings and loan associations.
Federal Reserve Bank of Dallas
Deregulation Committee
Adopts Some Final Rules
The Depository Institutions Deregulation Committee has issued several final rules regarding time
and savings deposits held at federally insured
depository institutions.
One rule, effective October 30, 1980 establishes
a ceiling ra te of interest for a new category of
time accounts-time deposits under $100,000 with
14 days as the minimum maturity. Depository institutions that are members of the Federal Reserve
System may pay interest on any time deposit of less
than $100,000 with an original maturity or notice
period of 14 days or more, bUL less than 90 days,
at a rate not to exceed 51/4 percent. Since no
ceiling rate exists for time deposits of $100,000
or more with an original maturity (or notice period)
of 14 days or more a rate may be negotiated
between the bank and the depositor.
The committee has also ruled that premiumswhether in the form of merchandise, credit or
cash-to depositors will not be regarded as payment of interest if:
1. The premium is given only when a new account
is opened, an existing account is renewed, or funds
are added to an existing account;
2. No more than two premiums per account are
given within a 12-mon th period;
3. The value of the premium or the total cost of
the merchandise does not exceed $10 for deposits
of less than $5,000 or $20 for deposits of $5,000
or more.
The committee has defined a finders fee as a
payment of interest to the depositor involved (subject to the applicable interest rate ceiling for
the deposit). ond such a fee is La be paid only in
cash. Both the premium and finders fee rules become cffectiv December 31, 1980.
Another rule that becomes effective December 31
prohibits the prepayment of interest to depositors,
in either cash or merchandise, on all deposits
subject to interest rate ceilings. However, deposiLory institutions may pay interest at maturity or
as it is earned. If merchandise is given in lieu of
cash, its cost must be certified b an executive
officer.
Inquiries from members of the Federal Reserve
System may be directed to Consumer Affairs, Bank
Supervision and Regulations Department, Federal
Reserve Bank of Dallas, (214) 651-6171.
November 1980/Voice
Regulation E:
New Amendments Adopted,
Proposed Amendment Issued
The Board of Governors of the Federal Reserve
System has adopted several amendments to Regulation E. One exempts certain family transfer plans
from the Electronic Fund Transfer Act and the
regulation. Another amendment permits institutions that ordered or purchased certain automated
teller machines (ATM's) before February 6,1980,
to omit a unique account identifier from the terminal receipt. The other amendments modify two
periodic statement requirements. The first of these
permits financial institutions to omit the state in
which a terminal transfer took place when the
transfer occurs within 50 miles of the institution's
main office. The second deletes from the regulation
a requirement that a certain receipt code be
printed on the customer's periodic statement. The
amendments became effective October 6, 1980.
The Board has issued for public comment an
amendment to Regulation E that would exempt
certain overdraft checking plans from the compulsory use prohibition of the EFT Act. The overdraft plans that are the subject of this proposal
generally require an agreement to debit a minimum
payment each monthly or other payment period
from available or advanced funds. Comments were
received through November 5, 1980.
17
"Bankers' Banks" Defined
The Federall\.eserve Board has issued an interpretation of Regulation D (Reserve Requirements of
Depository Institutions) that defines "bankers'
banks" and sets forth the criteria under which
bankers' banks may act as pass-through agents for
the reserves of other institutions. Under the
Monetary Control Act of 1980, bankers' banks are
exempt from Federal reserve requirements.
In its interpretation the Board ruled that an
institution qualifies as a bankers' bank if it is
organized solely to do business with other financial institutions and not the general public and
if 75 percent or more of its capital is owned by
the financial institutions with which it conducts
business.
A bankers' bank may act as a pass-through agent
for the reserves of other institutions if it enters
into an agreement with the Federal Reserve to accept responsibility for correctly maintaining
passed-through reserves and if the Federal Reserve
is satisfied with the quality of the management
and financial resources of the bankers' bank.
18
Consolidation Required
for Pass-Through Accounts
in Eleventh District
A correspondent handling pass-through reserve aL:counts in the Eleventh Federal Reserve District is
required to consolidate in a single account the
reserve balances of all its respondents whose main
offices are located in more than one territory of
the Eleventh District.
The pass-through correspondent should designate the specific Federal Reserve office in the
Eleventh District (Dallas, El Paso, Houston, or
San Antonio) in which the account is to be maintained. On the agreement form the pass-through
correspondent should also indicate whether the
pass-through account for its respondents is to be
commingled with its own reserve account or is to
be held as a separate commingled account for all
the respondents.
Federal Reserve Bank of Dallas
(}VowJIvailable
Recently issued Federal Reserve circulars, speeches, statements to Congress, publications, etc., may be
obtained by contacting the Bank and Public Information Department, Federal Reserve Bank of Dallas,
Station K, Dallas, Texas 75222, unless indicated otherwise.
Circulars
Results of Election. 1 p. Circular No. 80·204 (October 23,
Election of Directors: Report of Nominations-Voting Procedures. 19 pp. Circular No. 80-184 (October 1. 1980).
Regulation Z-Truth in Lending: Official Staff Interpretation. 7 pp. Circular No. 80-185 (October 1. 1980).
Public Information Statement: Community Reinvestment
Act. 6 pp. Circular No. 80-187 (October 2. 1980).
Policy Statement on Advertising of "NOW" Accounts. 3 pp.
Circular No. 80-189 (October 2. 1980).
Legal Agreement for Establishing Pass-Through Accounts
at the Federal Reserve Bank. 1 p. Circular No. 80-190
(October 1, 1980).
Federal Reserve Services. 30 pp. plus questionnaire on use
of Federal Reserve services. Circular No. 80-191 (October 9, 1980).
Revised Bulletin 5 [Currency, Coin and Food Coupons]. 11
pp. Circular No. 80-192 (October 15. 1980).
Revised List of OTC Margin Stocks. 20 pp. Circular No. 80193 (October 8. 1980).
Regulation E-Electronic Fund Transfers: Proposed and Final Amendments. 13 pp. Circular No. 80-194 (October
Questions and Answers on the Monetary Control Act. 19
pp. Circular No. 80-205 (October 27.1980).
Deferral of Reserve and Reporting Requirements. 2 pp. Circular No. 80-206 (October 24 or 27, 1980).
1980).
Pamphlets, Brochures, and Reports
The Depository Institutions Deregulation and Monetary
Control Act of 19BO. Reprinted from the Federal Reserve Bulletin. 10 pp. June 1980.
The Federal Reserve Discount Window. Published by the
Board of Governors of the Federal Reserve System. (A
booklet describing the programs under which Federal
Reserve credit is advanced) 13 pp. October 1980.
15, 1980).
Questions and Answers on the Monetary Control Act. 1 p.
Circular No. 80-195 (October 14. 1980).
Title 12-Chapter XII-Interest on Deposits: New Ceiling
Rate for 14-90 Day Time Deposits Under $100,000; Ceiling Rate for NOW Accounts; Premium and Finders
Fees Rules; New Prohibition of Prepayment of Interest
on Time Deposits. 19 pp. Circular No. 80-199 (October
23, '1980).
Speeches and Statements
Remarks by Paul A. Volcker ("The Burden of Banking Regulation") at the Annual Convention of the American
Bankers Association, Chicago, Illinois. 13 pp. October
14. 1980.
Regulation K-International Banking Operations: Notice of
Final Rulemaking Relating to Interstate Banking Restrictions for Foreign Banks. 12 pp. Circular No. 80-200
(October 27. 1980).
Final Revision to Regulation J [Collection of Checks and
Other Items and Transfer of Funds]. 18 pp. Circular
No. 80-202 (October 29, 1980).
November 19BO/Voice
19
@FedFRASER