Thursday, March 20, 2014

Slacking Off

Update (3/20): Alan Krueger has a highly relevant paper for the Brookings Papers on Economic Activity that concludes the long-term unemployed likely exert minimal influence on labor markets, including wage determination.

We're at the stage of the conversation about labor-market slack, it seems, where everybody is looking for the takeaways and points of meaningful agreement.

Cardiff Garcia has an excellent overview of how the debate on the labor-market slack issue has evolved. For people looking to dive in, Jérémie Cohen-Setton has a shorter look at the evidence and the arguments. Tim Duy says it was crazy that people ever thought that "overshooting" was ever in the cards. And Ryan Avent says no, it wasn't crazy -- and the case for a modest overshooting remains airtight.

Just a few odds and ends to share from me. I looked at the extent to which quits lead wages -- and found the lead time to be something on the order of a year, as you can see in this graph:

Regressing wages on 12-month lagged quits yielded a forecast for year-over-year increases in wages of about 3 percent. That was broadly in line with monthly and quarterly VAR estimates, including and excluding unemployment and consumption in the model. So something on the order of three-percent wage growth next year, and three-to-four-percent the year after that, both seems about right qualitatively and is what some simple modeling would predict.

That's not much to fear. What's been missed, though, is that the U.S. is not at the beginning of a normal tightening cycle. The federal funds rate is not one or two percent as it was in the 1990s and 2000s bottoms. It is zero. And there is billions in further easing beyond that.

When I look at the data and historical Fed behavior, it's hard for me to see a monetary policy that does not involve the beginning of an exit now and rate hikes in 2015. Even that incorporates some degree of overshoot -- if not in terms of inflation, as Avent wants, than certainly in terms of the unemployment rate.

It seems that, too, is the conclusion of the FOMC. The downward revision of the unemployment rate forecast now pegs full employment at the end of 2016. And the assessments of appropriate monetary policy suggest the FOMC is attached to the idea of rate hikes in 2015 and proceeding slowly from there.

1 comment:

  1. There is a difference between labour market slack and economic slack. The ability of capital formation to provide productivity increases which reduce inflationary pressure despite rising wages should not be underestimated. An over reliance on unemployment as an indicator of economic slack is a vote for supply side pessimism, which is particularly strange in the US where the shale revolution is driving down domestic energy prices, a positive supply shock by any measure. There is every chance that growth/productivity could return to its historical trend given the chance, but it seems virtually certain that the Fed will move to choke of demand growth and never give the supply side a reason to improve.

    Also, the relation between wage growth and inflation is murky at best - e.g. a tighter market could mean that workers capture more of their marginal product from corporations, leading to falling profit margins rather than rising output prices.

    Read the Clevland Fed paper:

    Or you can get my thoughts: