As I read it, it’s a fundamental, straightforward take on an issue that often gets unnecessarily complex: if the job market is really tightening, where is it in the wage trends?
Now, it’s true their data stops in 2011 and there’s been some tightening and some wage growth since then, though not much to see on the wage side, especially at the average (average annual nominal hourly wage growth, 2007-11: 2.6%; since then 2%). But the authors tell me they’ve updated the work through 2013 and the results are unchanged.
So what’s so important here? First, it’s this: their statistical analysis reveals that, just as Fed Chair Yellen often stresses, the unemployment rate is an inadequate measure of slack. What’s that? You knew that already? Well, that’s because you hang around here. Way too many people interpreted the big drop in unemployment last month as a sign of tightening though it was wholly due to the decline in the labor force.
More on that in a moment, but first, sticking with the labor force, B&P’s finding that including labor force inactivity in their wage analysis helps explain some of the variation (in a particularly important way I’ll show below) has a very important implication. If the depressed labor force is a statistically identifiable contributor to slack, then some of the current labor force inactivity can be reversed, much the same way unemployment comes down in the face of strengthening labor demand. Or, put differently, part of the decline in the labor force is just slack that’s not measured by the unemployment rate.
B&P quote Yellen as saying as much: “…some “retirements” are not voluntary, and some of these workers may rejoin the labor force in a stronger economy…a significant amount of the decline in participation during the recovery is due to slack…” B&P add their view that “…many individuals who are not actively searching for work under current labor slack conditions remain attached to the labor market.” All of which leads to their key punchline:
A substantial portion of those American workers who became inactive should not be treated as gone forever, but should be expected to spring back into the labor market if demand rises to create jobs.
Obviously, that has important implications for both the living standards of working-age households and macroeconomic growth.
Finally, their paper reminded me of a little fact that I’ve been noodling over for a while. You may recall a post related to all of this sort of thing a while back where I cited some important work by GS researchers showing that contrary to some recent analysis emphasizing the dominance of short-term over long-term unemployment in determining slack, in fact, broader measures of slack are better at predicting both wage and price growth.
But if you look at the GS figure in my post, they show that while it’s true that broader measures of slack do a better job at tracking recent wage growth, they still over predict. I’ve roughly replicated their findings using what I think is a similar index of various wage series (see data note if you want details). The blue line is just a quarterly index of wage growth (the same one I show here). Wg_indf1 is a forecast from a simple regression just using unemployment. Wg_inf2 adds the labor force participation rate, yielding a prediction that much more effectively captures the recent stagnation in wage growth.
It’s a simple but strong corroboration of B&P’s very important new finding. And it’s why getting back to full employment is so damn important!
PREDICTING WAGE GROWTH WITH AND WITHOUT THE LABOR FORCE PARTICIPATION RATE
Source: my analysis (see data note)
Data note: The wage index is the first principal component from four wage series: median weekly earnings of full-time workers, average hourly wages of production, non-supervisory workers, and hourly compensation from the productivity accounts, all in quarterly data. The first forecast (wg_inf1) predicts the growth of the growth of the index using just the unemployment rate, the second, more accurate forecast adds the labor force participation rate.