Janet Yellen’s Schizophrenic View of the Labor Market

by Patrick Brennan

Today markets were a little surprised when Federal Reserve chairman Janet Yellen projected that the central bank will probably decide to raise rates sooner than expected — early in 2015, probably, if economic projections hold up.

Yellen made it clear she thinks much more work needs to be done for the labor market, that especially the lower labor-force-participation and the number of people out of work for more than 26 weeks concerns her greatly. But she also cited a range of economic data indicating that the labor market is firming up (a view to some extent reflected by the committee’s consensus that rates should rise in 2015). These views aren’t contradictory — but if the jobs market is firming up in some ways, it’s not clear how much the Fed can afford to worry about its deeper problems.

In assessing when rates should be raised, the more subjective formulation the Fed adopted today just targets both full employment and an inflation target of 2 percent. The key question for the goal of full employment while keeping inflation reasonable is whether there’s “slack” in the labor market and how much there is — “slack” meaning that there are more workers who are suitable for jobs than there are jobs available from employers.

Former chairman Ben Bernanke believed there was a lot of slack in the labor market, and so does Yellen, and she thinks there’s a role for monetary policy in solving it. But increasingly, some economist are arguing there isn’t that much slack, even though 6.7 percent unemployment seems high, an issue the New York Times’ Binyamin Appelbaum raised in a question today​.

Why? For one, short-term unemployment has dropped to near-normal levels:

And as Yellen herself pointed out the rate at which people are quitting their jobs has risen noticeably:

And so has the prevalence of job openings:


She noted that these are both signs that workers and firms are increasingly confident about the state of the economy — and the labor market they’re dealing with doesn’t, based on these data, have much “slack.” But guess what’s not going up? As Yellen said, the rate at which people are getting hired:

Yellen also mentioned that the share of the U.S. population in the labor force or employed, period, remains extremely low. This could suggest that there is indeed a bunch of slack in the market. But it could also be because the rate of long-term unemployment remains stubbornly high, and labor-force participation continues to weaken inexorably and for demographic reasons — and the people that puts out of work may be splitting off from an increasingly tight labor market.

Chairman Yellen made it fairly clear, by repeatedly saying she thinks there’s a lot of slack, that she doesn’t think that’s what’s going on. In fact, she called that conclusion, that the long-term-unemployed and those out of the work force entirely are decoupled from the labor market ”tremendously premature.” It’s nice that she’s not buying into a new normal or abandoning the long-term unemployed.

But it’s not entirely clear how Fed policy will feasibly solve this problem, if she gives some credence to the view that the labor market is tightening in some ways. Another labor-market indicator she said she especially cares about: She wants nominal wage growth back up to something like 3 to 4 percent, where it used to reside during periods of healthy growth. But if she thinks there’s a bunch of slack in the labor market — that the long-term unemployed are going to get hired eventually and labor-force participation will rise or at least stop dropping — that might be a very long time away. Maybe she thinks accommodative monetary policy can accomplish that, but it might require, or at least risk, politically intolerable rates of inflation.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.