Aggregate Demand versus Job-Creation


Over the past year, we have extensively discussed how important job creation was in order for an economic recovery or expansion to keep running. This is especially true now that the leading economic indicators have decayed for 4 consecutive months.

Paul McCulley of bond giant PIMCO waxes eloquent on why we continue to see mediocre job creation, despite the past years improving demand side of the equation:

Click for larger graphic
Graphic courtesy PIMCO


“Despite aggressive and massive easing in 2001 – from 6½% to 1¾% for Fed funds – monetary stimulus was simply not getting sufficient “traction,” notably in fostering job creation and tempering disinflation expectations. The record of history said that such massive easing should be “working.” And, indeed, it was in stimulating aggregate demand, notably in the household sector. But there was a large slip between the aggregate demand cup and the job-creating lip.

Corporate America just wasn’t in the mood to meet indications of rising demand with more job supply, choosing instead to meet rising demand by goosing the productivity of the existing work force. Boosting profits by exploiting operating leverage is, of course, a time-honored tradition of capitalists. But this time ‘round, would-be employers had an overriding reason to exploit operating leverage: a concurrent need to reduce financial leverage.

This was particularly the case in 2002, in the wake of revelations that there were crooks – yes, crooks! – among the capitalist class, who had been blowing heinous smoke up the backsides of both stock and bond holders alike. Stock holders took their losses abjectly. But corporate bond holders didn’t, blowing out corporate bond spreads and de facto refusing to finance or re-finance any but highest grade issuers. Simply put, corporate bond investors demanded that Corporate America check into the Betty Ford Center for Balance Sheet Rehabilitation, most urgently those on the rating cusp between investment grade and junk.

McCulley has consistently had a level headed and insightful view of the economy and the Fed. He’s worth adding as a regular monthly read . . .

Managing It Forward
Paul McCulley, Managing Director
PIMCO, October 2004

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