San Francisco Fed Issues Productivity Alarm; POTC thinks CA's Budget Deficits will Become a Major Headwind for Equities in '10 ..

=DJ FED WATCH: SF Fed Warns Of 'Overly Optimistic' Job Outlook

By Michael S. Derby
A DOW JONES NEWSWIRES COLUMN
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NEW YORK (Dow Jones)--Strong levels of productivity are calling into question the U.S. economy's ability to generate jobs, a new report from the Federal Reserve Bank of San Francisco warns.
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The paper, released Monday, follows Friday's release of the January non-farm payrolls report. The U.S. lost 36,000 jobs and maintained its unemployment rate at 9.7% in the first month of the year. Financial markets greeted the data as a positive, largely because the month's series of major snow storms had been expected lead to big job losses. Hiring's relative resilience in the face of this pressure raised hopes a recovery in growth will soon be attended by rising payrolls.
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The San Francisco Fed research raises questions about that outlook. Written by staff economists Mary Daly and Bart Hobijn, the paper looked at the relationship between strong rates of productivity growth and hiring, and found reason to be worried.
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"Anecdotal evidence suggests that efforts to contain costs and remain nimble in the face of uncertainty have become a fixture in business strategy," the paper said. "If productivity keeps on growing at an above-average pace, then unemployment forecasts...could continue to be overly optimistic."
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The paper explained there's been a breakdown in how economists view the relationship between gross domestic product growth and hiring. At issue is Okun's Law, a forecasting rule used by economists. According to this tool, for every 2% real GDP is below trend, the unemployment rate should rise by 1%.
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The economists note that over 2009 real GDP was essentially flat while trend GDP rose by 3%. Under Okun's Law unemployment should have increased by 1.5%, when instead it rose by 3%.
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"The surge in labor productivity allowed employers to keep output steady while shedding workers and reducing hours of work in the economy," the paper said. "As such, it allowed unemployment to rise much more than expected given the change in GDP, breaking the normal pattern between the two measures observed over the past 60 years."
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The paper does not offer a prediction of what will happen with unemployment, except to say what many economists think will happen may be too optimistic.
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Meanwhile, while investors have gotten more upbeat about hiring, officials at the Federal Reserve expect that it will take a long time to get the unemployment rate to fall. They believe businesses, burned by their experiences over the last several years, will be hesitant to hire new workers, and will do so slowly even as demand picks up. That's a big reason why policy makers are so reluctant to raise interest rates.
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What's more, the jump in economic growth that happened in the closing months of last year was largely tied to the rebuilding of stocks drawn down during the recession, and as such, the gains were unsustainable. A cooler pace of growth is very likely for 2010.
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Still, for many economists, it remains an open question whether firms will be able to continue to push workers in the way they are now. Just as temporary factors made late 2009 GDP better than expected, it's possible firms will have to start hiring to better balance their output against demand.
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So while the jobs outlook is challenging just about any way you slice it, it remains an outlook fraught with uncertainty.
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(Michael S. Derby, a special writer with Dow Jones Newswires, has covered the Federal Reserve since 2001. He also writes about bond markets and the economy, and can be reached at 212 416 2214 or via email: michael.derby@dowjones.com)
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(END) Dow Jones Newswires
March 08, 2010 14:12 ET (19:12 GMT)
Copyright (c) 2010 Dow Jones & Company, Inc.- - 02 12 PM EST 03-08-10
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