Labor Markets: Considerations for Monetary Policy

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Thinking about EmploymentThe Federal Reserve in the 21st Century: A Symposium for College Professors Jane P. Katz

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The views in this presentation are those of the speaker and do not necessarily reflect the views of the Federal Reserve Bank of New York or the Federal Reserve System.

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Agenda Why does cyclical unemployment exist? (a quick reminder) Why are labor market measures important for monetary policymakers? “Maximum” employment is part of Fed’s dual mandate Labor indicators tell us about economic activity relative to potential What are the most important labor market indicators? The BLS Employment Situation Why it can be hard to judge labor market tightness/slack? The NAIRU is unobservable and moves around Current conditions in labor markets

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1. Why do we observe cyclical unemployment? Alternatively: Why don’t wages fall until firms want to hire everyone who wants to work? Cyclical unemployment occurs because the price of labor (wage) doesn’t adjust that flexibly. Fixed wage contracts, human resources policies, and norms and ideas about what is fair can make it difficult for firms to change wages (especially to cut them). If wages can’t adjust, a significant drop in demand for the nation’s output will tend to result in (1) layoffs which raise unemployment and (2) a reduced rate of employment growth.

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Not all unemployment can be addressed through monetary policy There can be unemployment in even the tightest labor markets (unemployment rates are never zero): Frictional unemployment Structural unemployment Although certain labor market policies might be helpful, monetary policy is not the way to address these sources of unemployment.

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2. Why are labor market measures important for monetary policymakers? The Fed’s legal mandate is “to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.” http://www.federalreserve.gov/aboutthefed/section2a.htm => Along with stable prices, employment is one target of monetary policy

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Unemployed workers are costly for the economy and for familiesOutput below potential is production/income that is permanently “lost” Output below potential may reduce investment and future output High unemployment is associated with decreased wellbeing, lower living standards, and increases in poverty Unemployment for some disadvantaged demographic groups rises disproportionately in recessions and shrinks disproportionately in expansions. (Bradbury, New England Economic Review, 2000) High unemployment has been implicated in higher incidence of divorce, increased rates of violent crime, and other social and individual ills

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Labor indicators are measures of overall economic activity relative to potentialLabor’s share of GDP is 75 percent Therefore, slack in the labor market is a key indicator of slack in the economy as a whole

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The bottom line for monetary policy:The Fed takes the mandate of maximum employment as maximum long-run sustainable employment. Unsustainably high levels of output raise inflation Or alternatively, compares its assessment of the economy with “full-employment” output the rate of GDP growth where output gap = actual output - potential output = 0

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In labor market terms, the yardsticks are:The non accelerating inflation rate of unemployment (NAIRU) Job growth rate consistent with maintaining full employment output

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3. What are the key labor market indicators?There are a wide range of reports: Bureau of Labor Statistics Employment Situation (monthly—first Friday) Employment Cost Index (quarterly) Real Earnings (monthly) Productivity and Costs (quarterly) Job Openings and Labor Turnover Survey (monthly) Employment and Training Administration Unemployment Insurance Weekly Claims (weekly)

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Employment Situation is the most closely watchedFrequent and timely The first Friday in the month for the previous month The latest release was on January 12, 2010 Two large, careful surveys Two independent readings of conditions Analysts track and write about them Economic models use them Releases and data are available at: www.bls.gov

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Employment Situation reports on two surveys: Household Survey Also called the Current Population Survey (CPS) Surveys 60,000 households Records labor market activity (or non-activity) of household members during week containing the 12th of month As reported by person answering phone

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Employment Situation surveys, continued:Establishment Survey Also called the Current Employment Statistics (CES) or Payroll Survey Includes 160,000 businesses and agencies at 400,000 worksites (covers 1/3 of non-farm workers) Records jobs, hours and earnings in pay period containing 12th of month Reported by employers

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Employment Situation’s two main indicatorsUnemployment rate From the household survey (CPS) Records share of labor force looking for work in last four weeks Provides detail by demographics, occupation, duration of unemployment, etc. Probably the most widely used indicator of degree of tightness or slack in the labor market (and by extension the overall economy) Payroll growth From the establishment survey (CES) Counts jobs in pay period, not people Provides detail by industry

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Dec 2009 Table A

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Caveats: What gets revised or is noisy?Unemployment rate Not revised (only minor seasonal adjustment fixes) But volatile--numbers can jump around, especially for smaller demographic groups (e.g., teens and Blacks) Payroll growth Sampling noise is minimal—huge sample Newest 2 months are preliminary; late-reporting employers cause revisions (usually not too big) Annual benchmarking can cause end-of-year revisions

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Usually CPS and CES tell the same story. But they can diverge due to: Revisions or sampling error Different treatment of self-employment, moonlighting, job-changers Omission of new firms in CES (“bias adjustment factor”) Labor force participation decisions (can affect job growth and unemployment rate differently) Population estimates used in CPS

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4. Judging labor market tightness or slack Compare labor market measures with the NAIRU and the rate of job growth consistent with full employment This is not an exact science: Potential output and the NAIRU are unobservable and change over time Affected by demographics, preferences, efficiency of labor markets, the tax code, immigration, etc.

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4. Labor market slack, continued Estimates suggest the NAIRU shifted down in the late 1960s, up after 1970, and down in the 1990s In 1980s, the NAIRU was probably above 7% Estimates as recently as a year ago put it in the neighborhood of 5.0%. Will a protracted recession cause it to rise as labor market skills among those not working depreciate Based on labor force growth trends, full-employment job growth is estimated to be approximately 150,000 jobs per month, ± 50,000

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4. Labor market slack, continuedThe behavior/timing of labor market activity over the cycle is not always the same. In the past, recessions slowed activity but jobs returned quickly when demand and production rose Recent recessions are associated with more structural change; jobs are redistributed among firms and industries (Groshen and Potter, Current Issues, 2003) Leads to “jobless” recoveries; production rises before job growth as it takes time for firms to establish new positions and hire new workers Riskier environment, so firms may hesitate Affects the speed and timing of labor market recovery

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4. How to judge labor market slack, continued Finally, measures of actual activity are necessarily imprecise: Any labor market measure can be noisy and/or volatile Different measures may paint a slightly different picture Especially since labor force participation is also cyclical

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It’s not surprising there can be disagreements about the appropriate monetary policy stanceThe gap between the NAIRU and the unemployment rate is subject to problems on both ends: The NAIRU is a moving target, estimated imprecisely, and with a lag that may be long enough to make it an uncertain guide for policy. Unemployment and employment measures are subject to noise, volatility, and revision. Still, it’s hard to improve on it as a measure of tightness/slack: A composite measure of labor market tightness did not appreciably outperform the unemployment gap in tracking wage inflation in most periods. (Barnes et. al., Public Policy Brief No. 07-2, Federal Reserve Bank of Boston)

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Current labor market conditions

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Unemployment remains at very high levelsUnemployment rate in December was unchanged at 10.0 percent Note that in more recent recessions, unemployment recovery has lagged the end of the recession

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As of December, U.S. economy had lost 7.2 million jobs since peak in December 2007Job decline in December (-85,000) larger than expected, but less than Q1 when losses averaged 691,000 a month Cumulative loss was 5.3% of peak (higher than 5 preceding recessions) Cumulative loss was more than 120% of gains during the prior expansion; in previous two recessions only about 7%

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Last Updated: 8th March 2018

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