The document summarizes key points from a discussion by the Chief Economist on structural factors affecting the US and European economies. It notes that unemployment in the US remains high due to structural issues in the labor and housing markets. The housing recovery has been weak due to structural factors like high foreclosure rates. It also discusses high public debt levels in the US and austerity measures in Europe contributing to high unemployment. Active labor market policies are needed to address structural unemployment.

1. To the Point
Discussion on the economy, by the Chief Economist April 30, 2012
The US: A risky negligence of structural factors
 Unemployment has fallen in the US, but the number of structurally unemployed
will remain high, and many have left the labour force. Structural factors in the
housing market, also, can explain why the recovery has been so weak so far, and
why the housing market will remain rather depressed.
 Economic policy in the US must pay more attention to structural factors, i.e.
reforming institutions so that labour and housing markets will work better. Also,
the fiscal challenges will be increasing, and without a well-functioning market
Cecilia Hermansson
economy creating growth, deleveraging will become harder.
Group Chief Economist
Economic Research Department
+46-8-5859 7720 Unemployment – some of it is likely to be structural
cecilia.hermansson@swedbank.se Deleveraging in the US economy has developed further than in the euro area when it
comes to debt in the financial sector and the household sector; however, the opposite
is true for public debt. The debt ratio in the public sector in the US this year is,
according to the IMF, 107%, rising to 113% in 2017, while it is “only” 90% in the
euro area at the moment, and falling to 87% in 2017.
The US has time to wait, as financial markets still have confidence, and 10-year
government bonds yield less than 2%. Both the American and the global economy
would even benefit from fiscal stimulus in the near term, if a medium-term plan to
reduce debt would be agreed and adhered to. Without this action plan – which should
be agreed to by next year at the latest – the fear of rising financial market instability
increases. Confidence is there until it is no longer there.
The euro area has few or no degrees of freedom. Austerity is the main focus, and,
increasingly, it is mixed with reforms that will also increase growth, albeit in the
medium term. In the meantime, recession is unavoidable, and unemployment is
reaching historical highs. Active labour market policies are needed at a time like this,
especially for all the young persons who have not been able to establish themselves in
the labour market and who risk staying out for a very long time. The social and
political consequences, on top of the economic ones, could be very negative.
At least in some parts of Europe, there is an awareness that unemployment – soon
reaching 11 % and increasing further – will have to be confronted, using active labour
market policies and structural reforms. To take actions to help young people out in
this situation is a better choice of policy than just relying on demand stimulus through
economic policies. From the fiscal side, there is not much room for demand stimulus.
In the US, the idea that some of the unemployed need active labour market policies
seems very far away. Unemployment has come down to 8.2% lately. The belief
among decision makers seem to be that most of this unemployment is cyclical. With
higher growth, unemployment will continue to fall. The problem is that, without so
many dropping out of the labour force, the unemployment rate now would be well
over 10%. The participation rate has fallen from 66% to 64% since 2008, and more
people are becoming passive. Also, as about 5.3 million people are considered as
long-term unemployed, assuming that one-third of them are structurally unemployed,
in need of new job skills, means that there are 1.75 million people with such needs.
No. 4
The US could learn from Europe in terms of active labour market policies. Although,
2012 04 30
they may not always have worked well, they can be useful after a financial crisis and
recession such as this one. The fiscal challenges are still great in the US, and
unemployment and passivity may constitute a problem for many years to come.

2. To the Point (continued)
April 30, 2012
The housing recovery – structural factors may hold it back
Chart 1: US housing market data
2,50 250 Since their highest point in April 2006, house prices in the US have fallen by
Case/Shiller house
2,25 prices for 10 cities---> 225 almost 35%. In the summer of 2009, it seemed as if a recovery would start, but
the current price level is actually the lowest since the summer of 2003. In this
2,00 200
Number of (millions)
sixth year of the housing market recession, what can be expected going
1,75 Residential construction 175 forward?
1,50 150
Index
Before looking ahead let us review recent history. Several factors explain why
1,25 125
the housing boom occurred, such as the democratisation of credit (easier access
1,00 100 to credit), the lower interest rates, the reduction of minimum down payments,
0,75
Sales of newhomes -->
75 the targeting of low-income borrowers both by politicians and credit
0,50 50 institutions, the lowering of credit standards, and the increased use of
Sales of existing homes -->
securitisation. Also, already in the 1990’s, demographics and higher household
0,25 25
90 92 94 96 98 00 02 04 06 08 10 12 income, due to the transition from one to two wage earners, were stimulating
Source: Reuters EcoWin
housing demand. As the research firm Graham Fischer & Co warned in 2001 “a
Source: Ecowin. home without equity is just a rental with debt”, the increased demand (and
supply) of housing in the US was unsustainable, and the virtuous circle of
higher homeownership due to greater leverage then turned into a vicious circle
of lower house prices as the number of foreclosures accelerated.
The main reason for the little recovery in house prices can be found in the
growing sales of existing homes. In the third quarter of 2010, the foreclosure
Chart 2: GDP growth (compared to potential
process was frozen, but increasingly these homes are now coming back to the
GDP growth) and unemployment in the US and
market. This could further depress the market, holding house prices down.
the euro area
Also, one of the reasons for the recovery is, while home owners are reluctant to
buy, investors have shown more risk appetite. Falling or stable house prices
could lead to a large sell-off by these investors, further postponing the recovery.
The homeowner rate has decreased from 69% to 66%, but this rate is still
higher than the rates prevailing before the boom and may fall farther. It is
important to look at structural factors such as demography and behavioural
aspects. The baby boomers are now starting to retire, and will continue doing so
for the next 20 years. Their housing equity is not what they had hoped for, and
their health expenditures will continue to increase. Household formation is
mainly occurring in the demographics that already own houses. Young people –
a smaller group than baby boomers – are saddled with gigantic student loans,
without the prospects of the vibrant labour markets their parents had.
From a behavioural perspective, a banking crisis and recession with a real
estate boom and bust usually lower interest in increasing household leverage
for some time. It is therefore likely that a recovery can occur, after the
Surce: Ecowin foreclosure process, but that it will be modest at best. The labour market will
remain weak, credit growth will be slow – due to both supply and demand
factors – and demographics will not increase homeownership more than earlier
generations. Also, the fiscal challenges are great, with higher taxes and less
room for social expenditures. Without a well-functioning market economy to
create growth, the deleveraging will be harder.
What are other implications of neglecting structural factors? First, there is too
much reliance on economic policies supporting growth, and too little on
structural reforms such as introducing institutions that can improve competence
and fixing housing-financing institutions. Second, there are people who will be
unemployed or burdened longer than necessary by housing debt; this is both a
loss for the individual and society. The most important thing is to work with
both cyclical and structural developments – this is always the rule, but
especially so after a crisis.
Cecilia Hermansson
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Cecilia Hermansson
+46-8-5859 7720
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