Why Janet Yellen and the Federal Reserve should make workers’ wage growth into a target

Wage inflation should be used as an additional target for monetary policy by the US central bank

 

Share

In a couple of recent speeches over the past month in Chicago and New York, Janet Yellen, chair of the Federal Reserve, made clear that the US central bank is going to focus attention on movements in a broad variety of labour market measures.

“As the attainment of our maximum employment goal draws nearer, it will be necessary for the FOMC [Federal Open Markets Committee] to form a more nuanced judgement about when the recovery of the labour market will be materially complete,” she said in New York on 16 April.

Ms Yellen identified four main labour market factors: underemployment and especially the number of part-timers who say they would like to be full-time; long-term unemployment; the labour force participation rate (LFPR); and wages. In part this has arisen because the unemployment rate, both in the UK and the US, fell more rapidly than had been expected. Movements of these variables are going to be crucial in determining when the Fed stops its asset purchase programme, which currently involves buying $25bn (£15bn) per month of agency mortgage-backed securities and $30bn per month of longer-term Treasury securities; and after that when it finally decides to start raising interest rates.

In a new paper, the former Bank of England Monetary Policy Committee member and now president of the Peterson Institute, Adam Posen, and I examined the implications of this unprecedented fall in the participation rate and found that it has major implications for Fed policy.* In the US the decline in the participation rate has been dramatic. The charts plot movements in the participation rate for those aged 16 and over in both the UK and the US for men and women. The participation rate is defined as the workforce, which is the number of unemployed plus the employed, divided by the population. It includes people out of the labour force such as students, home-makers and the retired.Of particular note is the fact that, for both men and women, until very recently, US rates were above UK rates. But the situation reversed in 2013. In the case of females there has been a steady rise in the participation rate since 1992, but in the US the upward trend that started immediately after the Second World War flattened out from around 2000 and then started to decline, with the rate of that decline accelerating with the onset of recession in 2009.

In the case of men, the series declines steadily in the US especially after 2008, while  in the UK it declines through the onset of recession and then remains broadly flat. It should be noted we have data for the US up to March 2014, whereas we only have it for the UK for December 2013 because the UK under invests in its labour market statistics which are less timely and of poorer quality than the equivalent US data.

Adam and I found that low and falling participation in the US is indeed an additional measure of labour market slack, pushing down on US wages, just as unemployment does. A substantial portion of those American workers who became inactive, in our view, should not be treated as gone forever, but should be expected to spring back into the labour market if demand rises to create jobs. If, as we show, the market wage is driven down when there are more inactives, then clearly those inactives are still part of the labour supply. If they were truly inactive, their local presence would have no impact on local wages. Plus if the labour force overall was truly shrinking because of demographics, the general effect should be upward pressure on wages – which we do not see.

Our findings also argue against the growing sense of pessimism that the recent decline in LFPR is largely irreversible. For example, the Congressional Budget Office projects that the LFPR will edge down only slightly over the next several years, falling to 62.5 per cent by the end of 2017, compared to 62.9 per cent in the fourth quarter of 2013. Our analysis also provides strong empirical support for the assessment that continuing labour market slack is a key reason for the persistent shortfall in inflation relative to the FOMC’s 2 per cent inflation goal. In other words, the inactivity rate is relevant for both parts of the dual mandate.

As Ms Yellen said in her Chicago speech on 31 March: “The decline in unemployment has not helped raise wages for workers as in past recoveries. Workers in a slack market have little leverage to demand raises... Wage growth for most workers was modest for a couple of decades before the recession, due to globalisation and other factors beyond the level of economic activity, and those forces are undoubtedly still relevant. But labour market slack has also surely been a factor in holding down compensation. The low rate of wage growth is, to me, another sign that the Fed’s job is not yet done.”

Adam and I argue that wage inflation should be used as an additional target for monetary policy by the FOMC. Unemployment has long been known to have severe problems as a guide post to monetary policy. By comparison, a general measure of the wage inflation rate encompasses most of the relevant indictors. If mismatch or demographic shifts limit the level of appropriate workers to below the level of demand, wages should be seen to be rising.

If, on the other hand, individuals are eager for more hours, or to return to the workforce, wages should be falling on average for the whole economy. So the FOMC, we argue, should set its forward guidance for the real economy in terms of wage growth, allowing the economy to recover until wage inflation indicates that labour slack has been absorbed.

Labour market slack in the US economy remains substantial, and subject to partial control by monetary policy. Wage inflation, we believe, should be considered as the primary target of FOMC policy with respect to the employment stabilisation side of the Fed’s dual mandate. Unlike unemployment, the rate of wage inflation requires less judgement and is subject to less distortion by such factors as inactivity.

*Adam Posen and David Blanchflower ‘Wages and Labor Market Slack: Making the Dual Mandate Operational’, Peterson Institute for International Economics

React Now

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
iJobs Job Widget
iJobs General

Recruitment Genius: Telesales & Customer Service Executive - Call Centre Jobs

£7 - £9 per hour: Recruitment Genius: Are you outgoing? Do you want to work in...

Ashdown Group: Finance Manager - Covent Garden, central London - £45k - £55k

£45000 - £55000 per annum + 30 days holiday: Ashdown Group: Finance Manager - ...

Ashdown Group: Systems Administrator - Lancashire - £30,000

£28000 - £30000 per annum: Ashdown Group: 3rd Line Support Engineer / Network ...

Recruitment Genius: Graduate Web Developer

£26000 - £33000 per annum: Recruitment Genius: A Web Developer is required to ...

Day In a Page

Read Next
 

i Editor's Letter: A royal serving the nation

Oliver Duff Oliver Duff
David Cameron met with Ukrainian President Petro Poroshenko prior to the start of the European Council Summit in Brussels last month  

David Cameron talks big but is waving a small stick at the Russian bear

Kim Sengupta
The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn
Yvette Cooper: We can't lose the election. There's too much on the line

Yvette Cooper: We can't lose the election. There's too much on the line

The shadow Home Secretary on fighting radical Islam, protecting children, and why anyone in Labour who's thinking beyond May must 'sort themselves out'
A bad week for the Greens: Leader Natalie Bennett's 'car crash' radio interview is followed by Brighton council's failure to set a budget due to infighting

It's not easy being Green

After a bad week in which its leader had a public meltdown and its only city council couldn't agree on a budget vote, what next for the alternative party? It's over to Caroline Lucas to find out
Gorillas nearly missed: BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter

Gorillas nearly missed

BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter
Downton Abbey effect sees impoverished Italian nobles inspired to open their doors to paying guests for up to €650 a night

The Downton Abbey effect

Impoverished Italian nobles are opening their doors to paying guests, inspired by the TV drama
China's wild panda numbers have increased by 17% since 2003, new census reveals

China's wild panda numbers on the up

New census reveals 17% since 2003