Wages, Slack, Labor Force Participation, and the Fed

May 5th, 2014 at 9:06 am

Good read from Binyamin Appelbaum this AM on a new paper tying together several recent themes around here, including weak wage growth (and the importance of the Fed not overreacting to it) amidst still slack labor markets, particularly once you factor in depressed labor force participation, as you must.

The paper, by Posen and Blanchflower, makes a couple of important contributions in these areas.  First, they show that if you want to understand the pressures, or lack thereof, on wages, unemployment alone isn’t enough these days—you also need to include labor force participation (btw, the stuff in the NYT piece about last month’s flat wage trend should be heavily discounted; that’s mostly monthly noise).  Quantitatively, they find that increasing unemployment is still a stronger determinant of wage trends—by about a factor of three.  Not surprising, since many who leave the labor force do so voluntarily.  But, especially lately, lots of leavers are responding to the lack of gainful opportunities, and that’s relevant in terms of measuring wage, and ultimately, price pressures.

Which brings us to their second interesting point, as Appelbaum writes:

Instead of counting heads, policy makers [at the Fed] can simply rely on market forces to do the work. Wage inflation, after all, is basically a summary of the balance between supply and demand. Employers raise wages as they find it harder to hire and retain qualified workers, so the market, in effect, is constantly judging the extent of labor market slack.

Chair Yellen has been explicit about wages as one of things she’s watching and I suspect much of what’s in this piece would resonate with her.  The question is how does a Fed governor gauge not just current wage trends, but expectations about future ones?  I’ve got some thoughts to share on that and will try to do so later.

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3 comments in reply to "Wages, Slack, Labor Force Participation, and the Fed"

  1. Jim Neal says:

    It’s a simple premise complicated by a fixation on the whether the ostensibly meaningless unemployment rate goes up or down. Fair criticism?


  2. Tom in MN says:

    Problem with the Fed watching wage inflation is that in the past they have panicked about inflation at every minor uptick. Their response over the last decade or so has been to slow the economy at the first sign of any wage inflation, which has to be partly to blame for the overall lack of wage growth.


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