Does Supply Matter During Recessions? Evidence from the Holiday Seasonal

Copyright, The New York Times Company

There will be almost three million fewer jobs next month than in December, and this outcome reveals a lot about how the labor market works.

As I noted last week, employment normally falls sharply after Christmas, for the obvious reason that consumer demand is significantly less in January than in the preceding December. Next month should be no exception.

Three million is a lot of jobs – that happens to be the total number of jobs that the Obama administration contended that it had “created or saved” over the entire life of the stimulus law passed in 2009. Yet next month’s multimillion loss of employment will be largely ignored by news organizations, because it will not be much different than it has been any other January.

But it’s big news that the seasonal employment cycle continues to operate as normal. The cycle is, of course, the outcome of seasonal fluctuations in supply and demand, and Keynesian economists insist that supply and demand have not been operating normally since the recession began and that the economy has been caught in a “liquidity trap.”

Keynesian economists assert that labor supply – the willingness of people to work – doesn’t matter right now, which is why they advocate government stimuli that increase “demand” spending even while they erode work incentives. As Paul Krugman put it: “What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant.”

In other words, a recession like the recent one is purported to be one of those rare times when demand is not constrained by supply.

My view is that lack of demand has not been the primary problem with our labor market, which is why the stimulus law has created no visible employment increase. Because of this disagreement among economists about the roles of supply and demand during recessions, it’s important to examine whether demand was operating normally during the latest recession.

If the Keynesians are right, the disappearance of Christmas demand in January would be even more devastating for total employment during a recession than it would be normally, when supply limits the effects of Christmas demand.

If so, the holiday employment seasonal would be about twice as large during recessions – with January job losses in a recession of five million or six million, compared with the normal three million.

The chart below tests the Keynesian claims by comparing the holiday employment cycle across years. Each series measures the deviation of December employment from the October-January trend (Christmas shopping begins after October and is finished by January).

The green and red bars measure employment from the establishment survey and the household survey, respectively, both conducted by the Bureau of Labor Statistics.

The average holiday seasonal data previous to the recent recession is shown at the left, and the rest of the chart isolates the season for 2007, 2008 and 2009, some, if not all, of which years when our economy was purported to be in a supply-doesn’t-matter liquidity trap. (For further description of these and related calculations, see this paper)

Take, for example, the green bars from the establishment survey. On average from 1980 to 2006, December employment exceeded the October-January trend by 1.5 percent. During the years 2007, 2008 and 2009, the December employment seasonal turned out to be similar – about 1.3 percent, rather than the 3 percent or so that we would expect if the economics of supply and demand were really as different during those years as Keynesian economists say they are.

The red bar of the household survey is noticeably lower in 2009 but well within the range observed over the past several decades.

You might think that Christmas became smaller during the recession, and that change offset the purported extra impact of each dollar of Christmas spending. It is true that almost all kinds of spending are lower during a recession, but I adjusted for that by measuring the seasonal data in percentage terms.

The retail sales data show that, in percentage terms, the holiday spending surge was not much different from 2007 to 2009 than it was in previous years.

People can argue about whether demand effects are marginally bigger during a recession. But the seasonal cycle clearly shows a recession does not free demand – whether it be holiday demand or government demand – from the constraints of supply.