One Expert's Opinion: Jeffrey Frankel on Highest Unemployment Rates in Nine Years

June 6, 2003 --The country's unemployment rate rose to its highest in nine years, climbing to 6.1 percent in May. Businesses cut 17,000 jobs during the month.  Nearly 9 million people were unemployed. Some economists say that this is not necessarily bad news because the economy has reached its bottom and is starting to climb.

Jeffrey Frankel is the James W. Harpel Professor of Capital Formation and Economic Growth and served on the Council of Economic Advisers during President Clinton's administration.

Q: Is the rise in unemployment bad news since it means less consumer spending and reduced economic growth?

Frankel: The big puzzle over the last two years is why employment has continued to stagnate, even to decline, while GDP has increased. It makes it hard to know whether we are in a real recovery.

Q: What are the reasons for this divergence between jobs and output?

Frankel: I have heard three explanations. First, that this is the usual cyclical pattern: because of the transition costs of hiring and firing, firms delay adding workers until they are sure that the expansion is well-established. But I don't buy this explanation; the adverse trend in employment has lasted for three years, and goes well beyond the usual pattern. The second interpretation is an optimistic one, that we are seeing a continuation of the rapid productivity growth of the late 1990s, and that this is good news for the long run trend. I don't buy this explanation either. If we were seeing a continued sustainable long-term trend of productivity growth, then workers should be sharing in the benefits in the form of corresponding growth in their real wages. They did in the 1990s, but real wages have been almost flat over the last few years. I subscribe to a third explanation: firms are desperate to show strong profit numbers, and so are cutting labor costs in any way they can -- real wages, weekly hours per worker, and employment. To me this does suggest that declining paychecks might put a halt to the increases in consumption that have sustained growth thus far.

Q: Why are firms behaving differently in this business cycle than in the past?

Frankel: I am not sure. But I think it has to do with the years during which firms reported accounting profits that were artificially high and analysts announced forecasts of future profits that rose unrealistically rapidly. Perhaps since the truth was revealed in 2001, firms have felt under pressure to bring their actual profits up closer to what investors had been led to expect.

Q: Is there a silver lining to this news?

Before Friday's announcement from the Bureau of Labor Statistics, the forecasts had been that the employment news for May might be even worse.

Q: What impact will this have on the stock market that has rallied a bit over the past few days?

Frankel: In response to such news of economic weakness, the markets have become increasingly convinced that the Federal Reserve will cut interest rates at their June 24 meeting. That is giving some support to the stock and bond markets.

Q&A Produced by Miranda Daniloff Mancusi
Photo by Martha Stewart