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.
