The Fed and “resource slack”

The Fed “measures” resource slack by what is happening to inflation. It looks, however, at certain numbers – unemployment relative to its view of what constitutes “full employment” and output relative to what constitutes “potential output” – to gauge what is likely to happen to inflation and therefore decide on the degree of monetary policy tightening.

For the past several years, the Fed has been “deceived”, with inflation remaining below target and with no indication that it will climb back to target anytime soon. The Fed´s “escape hatch” has been that the “low inflation” is due to “transitory factors”, but it is hard to accept that something “transitory” can last for so long!

Two recent posts have tried to gauge the degree of slack, concluding that the labor market has still some ground to improve before the “tipping point” is reached.

The one by Douglas Campbell, titled Public Service Announcement: The US Labor Market is Still Losing Ground Relative to Trend, shows a version of this chart

And concludes:

Of course, there are caveats here. Population growth did naturally slow a bit, and the absorption of women into the labor force was a one-time event that was mostly played out by the 2000s; 9/11 exogenously reduced immigration, and thus job growth, and the Boomers have been retiring, etc. Certainly, you could also quibble a bit with the trend. Yet, even if you plot the trend from 1945 to 1995, in recent years we still will not really have been gaining on this slower trend growth. These other events/excuses/caveats are not going to explain the relatively sudden collapse of employment some 20% +/- below trend. And why should exogenous negative shocks to labor supply cause wage growth to slow? I’m afraid I’m losing the plot of these other stories.

I have another explanation: maybe the economy is not really that overheated. 

Interestingly, the recovery from the 1990/91 recession was dubbed “jobless recovery”. The recovery from the 2001 recession was nicknamed “job loss recovery”. In the first, payrolls remained below, but close, to trend. In the second, payrolls fell significantly below trend.

What should we call the behavior of payrolls following the 2007/09 recession? The “job dump recovery”?

In 2003, this article published in the Kansas City Fed Economic Review “A Closer Look at Jobless Recoveries”, has an interesting discussion. I just don´t think the conclusions make sense to the “job dump recovery”. At the present time something more must be going on.

The other, by Adam Ozimek, titled There Is No U.S. Wage Growth Mystery, derives a wage growth Phillips Curve relation, with the rate of unemployment being substituted by the “non- employment rate” for prime-age workers and the wage variable given by the employment cost index for wages and salaries, shows a version of this chart

And concludes:

Wage growth is not really that mysterious if this level of slack is correct. Labor market pessimists who have pivoted from one theory to the next only to see them debunked by subsequent economic performance should consider the parsimonious explanation that there remains slack in the labor market, and they have underestimated it for years.

In her recent testimony before Congress, Yellen may be reconsidering:

Wall Street rallied after Fed Chairwoman Janet Yellen’s testimony to Congress this week, as she seemed to open the door for such a pause, by acknowledging that a recent decline in inflation further below the central bank’s 2% target may not, in fact, be as fleeting as policymakers had hoped.

We can only hope the FOMC Members come to their senses about the “degree of slack” in the economy.


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