Yellen’s ‘Hot’ Labor Market Evokes ’70s
Washington — Janet Yellen is pursuing a monetary policy with echoes from an era of bell-bottom jeans and New York Knicks’ basketball championships. And that’s got some economists worried.
In an unorthodox move, the Fed chair has signaled her intention to keep interest rates low enough to temporarily push unemployment modestly below its long-run natural rate. She described in a speech last month how a tight job market could entice discouraged workers back into the labor force, expand full-time employment, boost wages and possibly enhance efficiency.
“It’s OK to run what I would refer to as a high-pressure economy right now,” John Williams, who took over from Yellen as president of the San Francisco Fed in 2011, told reporters on Oct. 1. “That will help to get inflation back to 2 percent faster, which is important.”
Critics such as former Fed official Athanasios Orphanides say that’s the sort of policy the interest-rate setting Federal Open Market Committee followed in the 1960s and 1970s — with disastrous results. Inflation back then eventually surged to double-digit levels, exacerbated by a quadrupling in oil prices following the Arab oil embargo, as wages took off after the Fed allowed unemployment to fall to a low of 3.4 percent in 1968.
Gains in payrolls decelerated over the past two months as a global slowdown and financial-market turmoil hit the U.S. economy. The jobless rate though held steady as a contraction in the labor force offset a drop in employment. At 5.1 percent, it is just above the 4.9 percent that Fed officials reckon is equivalent to full employment, according to the median estimate of their assessments released on Sept. 17.
At first glance, worries about stepped-up inflation seem misplaced.
Measured by the Fed’s favorite gauge, prices were up a mere 0.3 percent in August from a year earlier, well below the central bank’s 2 percent goal.
Yet as Yellen herself has noted, policymakers have to be forward-looking because changes in interest rates affect the economy with a lag that can last for years.
And that’s where Orphanides sees reason to worry. He says there’s a danger that inflation — and more importantly, inflation expectations — will become unmoored if the Fed fosters an overheated economy for the next couple of years. That’s particularly a threat if unemployment falls further than the Fed expects because the labor force and full-time employment opportunities don’t expand as much as Yellen hopes. In that case, even some central bank officials may start to question her strategy.
Policy makers see the jobless rate dropping to 4.8 percent in the fourth quarter of next year then holding there through 2018, according to their median projection.
“I’m alarmed that the Federal Reserve sees its job as finding everybody a job in the economy,” said Orphanides, a former governor of the Central Bank of Cyprus who is now a professor at the Massachusetts Institute of Technology in Cambridge. “That is what is creating long-term risks.”
The late Arthur Okun— an economist whom Yellen has openly admired — made the case for policymakers encouraging a high-pressure economy in a Brookings Institution paper in 1973, saying it would be good for workers and the U.S. as a whole. Echoing Okun’s arguments, Yellen said in the Sept. 24 speech in Amherst, Mass., that “a period of especially plentiful employment opportunities and strong hiring” might be needed to attract discouraged workers back into the labor force and convince companies to turn part-time jobs into full-time ones.
She also said she expects the first Fed interest-rate increase since 2006 later this year, followed by a “quite gradual” pace of tightening thereafter.
While many economists support Yellen’s strategy — it “is a risk worth taking,” Northwestern University professor Robert Gordon said — others are not so sure.
Charles Plosser, who served as head of the Philadelphia Fed for nine years before stepping down in March, voiced misgivings about Yellen’s focus on boosting labor-force participation and full-time work. “I know of no good economic theory” that says the central bank can tackle those issues, he said. The Fed “is setting up expectations it can’t meet. That could undermine its credibility.”
Some of the Fed’s own research raises questions about how much impact the central bank can have on the size and composition of the workforce.
In a 90-page paper last year, six staff economists with the Fed board in Washington cautioned policy makers not to expect a substantial increase in labor force participation as the job market improves. That’s because much of the drop is being driven by the retirement of aging Baby Boomers and not by the state of the economy, they wrote.
The participation rate, the share of working-age people employed or actively looking for a job, dropped to 62.4 percent in September, the lowest since 1977.
With participation unlikely to increase, Peter Hooper, chief economist at Deutsche Bank Securities Inc. in New York, said he sees unemployment falling to the “low 4s” by the end of 2016. That would occur just as the forces temporarily weighing down inflation, such as weaker oil prices and a strengthened dollar, may be subsiding, he added.
If wage pressures intensify as a result, “it could definitely create some tension within the FOMC in terms of running the economy hot as the rationale for policy,” said Richard Clarida, a New York-based global strategic adviser for Pacific Investment Management Co.
Strains within the FOMC may be heightened next year because three of the more hawkish officials — Presidents Esther George of Kansas City, James Bullard of St. Louis and Loretta Mester of Cleveland — will be voting members in 2016, he noted.
Even the San Francisco Fed’s Williams suggested to reporters last week that there were limits to how long the Fed should run a high-pressure economy. While he’s “totally cool” with doing that now, he said he wouldn’t support allowing unemployment to “stay in the mid-4s or low-4s, for a long time,” assuming a natural rate of about 5 percent.
“I don’t think it would be good,” he said.
