Investment-Unemployment Link Still On Track

When the recovery was getting started I pointed out the remarkably strong inverse relationship between fixed investment as a share of GDP and the unemployment rate, and argued that a policy that focused on getting businesses to invest more would help get the unemployment rate down.

The additional data from the past several years gives us a chance to check whether that relationship has held up. As shown in the following two charts, it has held up quite well.  The first time series chart shows that as investment has turned up as a share of GDP, the unemployment rate has fallen.  The increase in fixed investment thus far has been largely in the form of business fixed investment, though residential started to pick up last year.

The second chart is a scatter plot with unemployment on the vertical axis and the investment ratio (in percent) on the horizontal axis. The lines connecting each quarterly observation represent the path from one quarter to the next. The chart illustrates the close correlation between the two variables. It also shows that the movement of unemployment and the investment ratio during the recovery (the recent dates are marked) has roughly paralleled the path in the recession, but in the reverse direction.  The problem, of course, is that the reverse path is way too short.  Investment has increased very slowly and has a long way to go before it gets back to levels that correspond to the 5 percent range for unemployment that we would like to see.  So the message in the charts is much the same as several years ago: economic policies that focus on more private investment are likely to also reduce unemployment.

These diagrams would look very much the same if the denominator in the investment ratio was potential GDP rather than actual GDP. Of course, things other than investment can affect unemployment, and the correlation does not prove causation. As I pointed out here in a reply to comments on my original post, the correlation between investment and unemployment was also strong in the 1970s, through the scatter of points would be higher in the diagram then because demographic factors raised the average rate of unemployment.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

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