States Where Unemployment Claims Are Decreasing the Most | WalletHub

Thomas S. Nesslein

Ph.D. – Associate Professor (Economics) – University of Wisconsin – Green Bay, Austin E. Cofrin School of Business

It has been evident for about a year now that the economy has started to slow down, but the Federal Reserve has yet to lower its base interest rate, standing for some time at a 23-year high of 5.25–5.50 percent. Inflation currently has fallen to around 3 percent, although still higher than the Federal Reserve’s inflation target of 2 percent per year. Even more important, recent revisions to the estimated unemployment rate suggest that the official statistics may have overestimated employment by some 800,000. This and other data suggesting a slowing economy have finally moved the Fed Chairman, Jerome Powell, to clearly indicate that the time has come to cut interest rates to try to prevent further deterioration in the labor market. Consequently, the Fed will begin to cut interest rates at its September meeting. But the size of the coming interest cuts remains uncertain. The Fed never cuts interest rates by, say, 2 percentage points in any short time span. It would be too disruptive to financial markets. At their six-week meetings, the Fed traditionally cuts interest rates either one-quarter of one percent or one-half of one percent. Of course, the Fed meets several times a year, and over a year there may be, say, a one percentage point cut to 4.25–4.50 percent.

Now at a personal level, one may ask whether the pending modest interest rate cuts should significantly alter one’s investment decisions. Probably not. While bonds and stocks are substitute forms of investment and lower yields on bonds give some incentive for increasing equity investments, stock market prices are also greatly influenced by expected corporate profits. Given the slowing economy and the great uncertainty of future government policy, little basis exists for a significant shift into equities at this time.

The major, broad question that arises is whether these phased-in interest rate cuts will have much stimulus to total spending, thus stabilizing national production and employment. There are many reasons for being skeptical in this regard. To begin, it is clear that the 20 percent jump in consumer prices on average over the last three years is beginning to slow consumer spending, which represents some two-thirds of all spending in the economy. Workers’ real purchasing power has clearly fallen significantly over the past three years, many households have exhausted their COVID relief funds and transfers, and consumers have been using their credit cards to stay afloat for some time. Consequently, credit card debt has been rising, along with credit card defaults. Changes in the Federal Reserve’s base rate, of course, will not affect existing credit card rates, and future credit card rates only adjust extremely slowly. A related issue is that due to extremely high credit card rates, many consumers have turned to “Buy Now, Pay Later” financial products. These products allow them to pay for purchases at intervals over time. There are no government statistics on these installment loans, so it is unclear the outstanding amount of these loans and the recent default rate on this “phantom debt.” Another troubling fact that a recent study uncovered in one of the college student loan programs is that where student debt was canceled, the purpose, of course, was to help students reduce their debt load. But the study found that students, on average, actually increased their debt load by $2,000. Finally, consumer expectations are also a key factor determining the amount of consumer spending. With unemployment rising and many uncertainties surrounding future government spending, taxation, regulatory, and tariff policy, clearly, consumers have an incentive to spend much more cautiously.

However, some may wonder: With interest rate cuts, will not the fall in mortgage rates stimulate this important sector of the economy, helping to stave off higher unemployment? This is, however, unlikely to be the case. First, average housing prices have been driven up far beyond the purchasing power of average households. According to the National Association of Realtors, the median existing home price in early 2020 was $300,000. Currently, the median home costs some $422,000. If the supply of existing homes for sale increased markedly, it would be of some help in bringing down home prices modestly. Over the last year, however, existing home sales, which represent the major supply of housing to buy, actually fell 2.5 percent. Most existing homeowners bought their housing before 2020 and have extremely low mortgage rates of 3 to 4 percent and have virtually no incentive to sell.

Moreover, many people forget that the monthly mortgage payment is only a part of the cost of homeownership. Other key costs include property tax payments, home insurance, maintenance costs, and utility costs. Several of these costs have increased much more than the average rise of the price level since 2021 of 20 percent.

Consequently, little basis exists that mortgage rate decreases over the next two years or so will have more than a marginal stimulus to consumer spending. And, of course, if people do not move to new homes, there is less spending on all the complementary goods to home sales such as spending on furniture, appliances, and maintenance.

Turning to another important component of spending, investment spending by the business sector on new plants and equipment, again, decreases in interest rates will have a very limited positive impact. One must keep in mind that the amount of business investment spending depends on all the factors that influence profit expectations, which can clearly outweigh the positive effect of modest interest rate cuts. With the upcoming elections, tremendous uncertainty exists with respect to federal government spending and taxation decisions, regulatory policies, tariff policy, climate policy, and the health of the international economy. Until there is more clarity on these factors, businesses are reluctant to make major investments. If anything, certain business sectors are closing plants or reversing planned investments. A good example is the large scaling back of EV production plans by General Motors and Ford. International trade issues are especially relevant here. The Wall Street Journal reports that China is trying to solve its domestic employment problems by vastly expanding the production capacity of their entire industrial sector, which far exceeds domestic demand. For example, China has added the ability to produce some 40 million EVs a year, even though domestic demand is only about 22 million a year. China hopes to sell all excess industrial goods on the world market, adding to the employment problems of the United States and around the world. Consequently, trade policy will be an extremely contentious issue in the immediate future.

In summary, I believe the Federal Reserve’s pending interest rate cuts over the next year will have little effect on stimulating total spending in the economy, thus raising production and employment. Consequently, whether we have a slowing economy—that is, positive but small increases in production, with mildly rising unemployment—or actually a recession with falling production and significant unemployment will surely depend almost entirely on the fiscal policies implemented over the next year or two. Clearly, the two political parties have vastly different economic agendas in terms of the level and composition of government spending, taxation and transfer payments, and regulatory and trade policy. Until the November elections give some clarity on these issues, it is not possible to make reasonable predictions about future economic growth and the employment situation.