Stock Market Dispersion i and Long-Term Unemployment Jinzhu Chen Prakash Kannan Prakash Loungani and Bharat Trehan October 22, 21 Prepared for an IMF workshop on The Unemployment Crisis: Causes, Costs and Cures
Cumulative increase in unemployment during the Great Recession was particularly l high h in the U.S. Peak-to-trough Changes in Unemployment Rates During the Great Recession 8 7 Points Percentage 6 5 4 3 2 1-1 DEU AUS NOR JAP ITA NLD BEL PTL FRA NZL SWE GRC AUT DNK CAN FIN GBR USA IRL ESP
Do you want jobs with that recovery? 11 12 1 99 1 8 U.S. GDP 98 97 6 4 Unemployment Rate (Right Scale) 96 2 95 27 - Q4 28 - Q3 29 - Q2 21 - Q1
More worryingly, the average duration of U.S. unemployment has inched up Figure1. Average Duration of Unemployment (In weeks) 35 3 25 2 15 1 5 1948 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21
reflecting increases in long-duration unemployment spells Figure 2. Unemployment Rate by Spells 4 4. 35 3.5 5 to 14 weeks Upto 5 weeks 3. 3.5 2.5 3. 2. 2.5 1.5 1. 2..5 1.5. 1948 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 1948 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 2.5 14 to 26 weeks 4.5 26+ weeks 4 2. 35 3.5 3 1.5 2.5 1. 2 1.5.5 1.5. 1948 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 1948 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21
Can the rise in U.S. unemployment duration be explained by the changing intensity of sectoral shocks? Difficult identification question. One possible measure of sectoral shocks: dispersion in industry stock returns (Loungani, Rush and Tave, JME 9, and Brainard and Cutler, QJE 93) Motivated by Fischer Black (1987) The sector-by-sector behavior of stocks is useful in predicting sector bysector changes in output, profits, or investment. When stocks in a given sector go up, more often than not that sector will show a rise in sales, earnings, and outlays for plant and equipment... We could use the behavior of individual sectors of the stock market to predict unemployment. If my theory is correct, large moves in opposite directions in different sectors should be followed, normally, by an increase in unemployment.
U.S. Stock Market Dispersion Index.25 Dispersion Index (6-months Moving Average).2.15.1.5 1955Q1 1959Q1 1963Q1 1967Q1 1971Q1 1975Q1 1979Q1 1983Q1 1987Q1 1991Q1 1995Q1 1999Q1 23Q1 27Q1
The take-away slide Stock market dispersion can explain variation in U.S. long-duration unemployment 3 25 Variance of Unemployment Explained by Dispersion (at horizon 4) 2.5 Historical Decomposition of Long-Term Unemployment Rate 2 LTU Rate 2 15 1.5 Baseline Dispersion Shocks 1 1 5.5 Unemp. Rate Up to 5 weeks 5 to 14 weeks 15 to 26 weeks 26+ weeks 23 24 25 26 27 28 29
Details 6-variable VAR GDP growth Market return (S&P 5) Long-Term unemployment rate Inflation Federal funds rate Stock market dispersion i index
Response to Cholesky One S.D. Innovations ± 2 S.E. Response of UN27_ON to GROWTH Response of UN27_ON to SNP.3.3.2.2.1.1.. -.1 -.1 -.2 2 4 6 8 1 12 14 16 18 2 -.2 2 4 6 8 1 12 14 16 18 2 Response of UN27_ON to UN27_ON Response of UN27_ON to INF.3.3.2.2.1.1.. -.1 -.1 -.2 2 4 6 8 1 12 14 16 18 2 -.2 2 4 6 8 1 12 14 16 18 2 Response of UN27_ON to FFR Response of UN27_ON to DISP.3.3.2.2.1.1.. -.1 -.1 -.2 2 4 6 8 1 12 14 16 18 2 -.2 2 4 6 8 1 12 14 16 18 2
Dispersion matters for long-duration unemployment Forecast-error variance decomposition for long-term unemployment Horizon (Quarters) Growth Market Return Long-Term Unemp. Inflation Fed Funds Rate 5 37.1 12.9 38. 2.3 1.9 7.9 1 31.6 23.5 2. 2.2 1.8 2.9 Dispersion 2 25. 19.3 15.8 11.7 3.3 24.9 4 24.5 17.11 14. 12.9 34 3.4 28.1
Shocks to dispersion account for significant part of the rise in long-duration unemployment during the recent recession 2.5 Historical Decomposition of Long-Term Unemployment Rate 2 LTU Rate 2 LTU Rate Baseline Baseline 1.5 Growth Shocks 1.5 Dispersion Shocks 2.5 Historical Decomposition of Long-Term Unemployment Rate 1 1.5.5 23 24 25 26 27 28 29 23 24 25 26 27 28 29
Peeking under the hood Is the stock market dispersion index really picking up sectoral shocks? Two alternative stories: 1. Index is a proxy for uncertainty (Bloom, 29) 2. Index is nonetheless picking up aggregate shocks
Positive correlation between stock market dispersion index & Bloom measure 2.5.25 Uncertainty t index Dispersion i index 6-mma (i (right side) 2. Correlation:.552.2 1.5.15 1..1.5.5.. 196Q1 1962Q2 1964Q3 1966Q4 1969Q1 1971Q2 1973Q3 1975Q4 1978Q1 198Q2 1982Q3 1984Q4 1987Q1 1989Q2 1991Q3 1993Q4 1996Q1 1998Q2 2Q3 22Q4 25Q1 27Q2 29Q3
Perhaps both indices can bloom? Response of LT Unemp. Rate to 1 s.d. Innovation to Uncertainty Response of LT Unemp. Rate to 1 s.d. Innovation to Dispersion.12.25.8.2.15.4.1..5. -.4 -.5 -.8 -.1 -.15 -.12 5 1 15 2 25 3 35 4 -.2 5 1 15 2 25 3 35 4
Dispersion index is better at explaining variation in Long-Term Unemployment 3 25 Variance of Unemployment Explained by Uncertainty(at horizon 4) 3 25 Variance of Unemployment Explained by Dispersion (at horizon 4) 2 2 15 15 1 1 5 5 Unemp. Rate Up to 5 weeks 5 to 14 weeks 15 to 26 weeks 26+ weeks Unemp. Rate Up to 5 weeks 5 to 14 weeks 15 to 26 weeks 26+ weeks Forecast-error variance decomposition for long-term unemployment Horizon (Quarters) Growth Market Return Long-Term Unemp. Inflation Fed Funds Rate Uncertainty Dispersion 5 3.7 13.7 37.8 2.6 2.8 6.4 6.1 1 29.8 22.4 2.9 2.5 1.6 2.9 19.9 2 23.3 17.4 16.4 12.5 4.2 4.7 21.5 4 22. 16.1 14.4 15.8 4.1 4.7 22.9
Aggregate shocks by another name? Evidence seems to suggest that index is picking up something different from aggregate shocks: 1. Regression tests show that dispersion index is not correlated with neither Romer and Romer monetary policy nor fiscal policy shocks (both contemporary and lags). 2. Behavior of sectoral indices during recessions seem to match conventional wisdom.
Cons. Discretionary Financials Energy Cons. Discretionary Financials 1974-75 Energy 1979-8.% 2.% 4.% 6.% 8.% 1.%12.%14.%.% 1.% 2.% 3.% 4.% 5.% Industrials Energy Energy Cons. Staples Financials 1981-8383 Utilities 199-9191.% 1.% 2.% 3.% 4.%.% 2.% 4.% 6.% 8.% 1.% 12.% Information Technology Financials Health Care Materials Telecommuncations 2-1 Cons. Staples 27-9.% 1.% 2.% 3.% 4.% 5.%.% 5.% 1.% 15.% 2.%
Conclusions Recessions leave scars on the labor market; the Great Recession has left gaping wounds Duration of unemployment has gone up dramatically in the U.S. Separating aggregate from sectoral shocks is a difficult task, but our proxy for sectoral shocks the dispersion of stock returns seems to indicate that sectoral shocks may be part of the explanation for the increased duration in the U.S. In ongoing work, we look at international evidence for the link between the stock market dispersion index and unemployment. Preliminary findings are encouraging.