The headlines following last week’s meeting of the Federal Open Market Committee seemed either to focus on the markets’ reactions to them (because numbers are easier to talk about than policy) or one aspect of the comments — that new Federal Reserve Chair Janet Yellen expressed some hesitation with what had previously been considered a line in the sand when it came to Fed rate policy — that a 6.5% unemployment rate would be a clear signlal that it was time to start raising interest rates.
Unemployment is still too high to raise rates
Rather, the Fed would look at unemployment and underemployment more holistically because the top-line number — which hovered just above the prior target at 6.7% at the beginning of March — under-describes the problem. Specifically, it doesn’t count the millions of Americans who have become so frustrated by their lack of job prospects that they’ve stopped looking altogether — and thus under the narrow definition of “unemployment” aren’t counted — nor does it count the many part-time workers who would prefer to be working full-time, but can’t find anyone who’ll take them.
Thus, expect loose monetary policy to stick around a little while longer — even as the unemployment rate continues to fall.
Could keeping rates low in hopes of affecting the unemployment rate instead just lead to more inflation?
Before continuing, it’s important to get a reminder on prevailing theory on the link between unemployment and inflation. When unemployment gets low — with Fed help or otherwise — wages paid to workers increase more rapidly leading to inflation. Google the term “Phillips Curve” if you want a little more.
Chair Yellen quietly addressed a different question related to unemployment on March 19:
“With respect to the issue of short-term unemployment, and it’s being more relevant for inflation and a better measure of the labor market, I’ve seen research along those lines. I think it would be tremendously premature to adopt any notion that says that that is an accurate read on either how inflation is determined or what constitutes slack in the labor market.”
This addresses an idea that I’ve been hearing from more and more folks in the economics sphere in recent months.
That “research” picked up an important ally just one day after Yellen’s answer in the person of Princeton University professor and sometime Obama Administration adviser Alan Krueger who published a new paper with data that addresses several aspects of the topic:
- It’s even worse for the long-term unemployed than we thought. The long-term unemployed who have given up and left the labor force are unlikely to re-enter, with many saying that they no longer want a job. Not only that, about one-third of the long-term unemployed who stick to it and eventually find a job are likely to be unemployed or out of the labor force again in a year. Part of this may stem from the fact that the long-term unemployed are more likely to stay in their same field than previously thought — not switching to fields with better prospects as economic theory sometimes predicts.
- Even if the Fed manages to help the economy get better, it may not help the long-term unemployed. Looking at empirical data at the state level, Krueger found that there was only a very weak correlation between the overall level of unemployment and employment prospects for the long-term unemployed. In fact, they were just about as likely to find a new job as they were to leave the labor market entirely.
- Short-term unemployment affects inflation; not total unemployment. Critics of the Phillips curve point to the disjointed relationship between inflation and unemployment since the financial crisis (Others still point to the high-inflation, high-unemployment days of the stagflation 70s). However, there’s a much cleaner relationship between wages and unemployment when you only look at short-term unemployment.
Read the whole paper if you have time. It’s really interesting.
It’s important to note that short-term unemployment is pretty much at pre-crisis levels.
Anyhow, what does all this imply is happening on the ground?
My take is that, if true, it says that if the economy improves further and businesses start looking to hire more workers, they’re more likely to poach already-employed workers — presumably by offering higher wages — than to give a shot to someone who’s been out of work for a very long time.
Anyhow, your thoughts?