Short version: A group of Fed researchers presented a paper that rebuts the slack in the labor market argument. The Fed, therefore, is likely to continue its rate hikes beyond the expected 5% funds rate.
Long version: Keep reading . . .
In 2004 Katharine Bradbury, a Senior Economist at the Federal Reserve Bank of Boston, published research suggesting that "labor force participation rates post recession have not recovered as
much as usual."
This was an early explanation for what has been one of the weakest post-recession labor recoveries in the post-war period. (We’ve detailed this many times in the past).
Last week, a different group of Federal Reserve researchers came to the opposite conclusion. This group determined "U.S. unemployment really is low and the jobless rate hasn’t been
artificially depressed by a failure of many discouraged workers to be
counted as unemployed."
The heart of the study wades looks at the "failure of more people
to seek work since the recession ended in 2001. The "participation
rate" — the proportion of working-age people working or looking for
work — peaked at 67.3% in 2000, fell to 65.8% in March 2005, and has
since recovered to 66.1%, below where it stood for most of the 1990s. (WSJ)"
Amongst other factors, the research group noted that the hot job market of the 1990s pulled many more people into the labor pool than normal. They also blamed the "aging of the baby boom cohort" and other structural changes.
While the group’s conclusions are arguable, the more important aspect of this is that it — incorrectly or not — gives the Federal Reserve the ammo it needs for continuing their tightening campaign. The Fed is now fighting a ghost: a tight labor market that doesn’t exist, wage inflation that actually fails to keep up with price increases, and full employment that is hardly anything of the sort.
This adds to the liklihood that the Fed will do what Feds typically do: tighten rates beyond what’s necessary to merely cool inflation. After all, an economy with full employment, a tight labor market and rampant wage increases are the perfect growing conditons for blossoming inflation.
If only those conditions actually existed . . .
The WSJ notes that some analysts (present company included) believe "the low participation rate means many people aren’t seeking work because they believe no desirable work is available and aren’t counted as unemployed. The economists believe the unemployment rate — which at 4.8% in February was low enough to qualify as "full employment" in many conventional views — may mask underlying labor-market weakness. A staff study by the Federal Reserve Bank of Boston a year ago argued the unemployment rate, then about 5.4%, might understate the actual degree of unemployment by one to three percentage points."
As the chart nearby makes clear, the participation rate has fallen dramtically since the recession.
The employment rate is a fraction: the numerator (top number) are those people working, and the denominator (bottom number) are those in the labor force. Total employment goes up — and unemployment goes down — when EITHER the top number rises (more people working) — OR the bottom number falls (less people in the labor force) — or a combination of the two.
A drop of more than 2 percent of the labor force — 140 million people strong — means that nearly 3 million former workers are neither working nor looking for work. Their departure from the pool makes the unemployment measure go down.
During most recoveries, the participation rate typically rises as these "discouraged workers" return to work.
While I find the group’s research conclusions suspect, I would point interested readers towards the report, pages 67 forward. A rich collection of charts tell provide lots of fodder for more discussion on the subject . . .
click for larger charts
Participation rate rolling over
Classic Economist Error: Projecting a cyclical trend — to infinity
Various Labor Pool Participation Rates, Demographics
Fed Analysts Say Low Jobless Rate Doesn’t Mask Labor Market Woes
WSJ, March 31, 2006; Page A2
Brookings Panel on Economic Activity
March 30 and 31, 2006
The Recent Decline in Labor Force Participation and its Implications for Potential Labor Supply
Preliminary Draft (PDF)
by Stephanie Aaronson, Bruce Fallick, Andrew Figura, Jonathan Pingle, and William Wascher
Division of Research and Statistics, Board of Governors of the Federal Reserve System, March 2006
U.S. jobless rate misses "hidden" unemployed
By Reuters | June 14, 2004