Monday, November 3, 2014

How much slack is there in the labor market?

Economists at the Cleveland Fed compile different estimates of "labor market slack" and of the "normal unemployment rate." I think the most important sentence in their commentary is:

There is considerable uncertainty surrounding the estimates, so we cannot draw sharp conclusions about the amount of slack, or about differences between slack estimates. 

Also, look at the chart of the estimates of slack:

At least three of the metrics dip below zero during business cycle expansions (the green line, the purple line, and the blue line). That means job market slack turns negative, or that the market gets too tight. Is that something policymakers should shoot for? How about the risks associated with a monetary policy that, while it "gets more people employed," also creates distortions and imbalances elsewhere? 

The most recent data points are hard to read off the chart, but it seems to me that most measures are between 0% and 0.5%, if not below. So, whereas there is uncertainty, this evidence suggests that slack is somewhere between small and non-existent. What is the optimal monetary policy in the presence of this small but uncertain job market slack? Keep monetary conditions loose, just in case? 

More and more, it seems to me, the Fed is looking only at one side of the risk (i.e. the risk that monetary conditions are too tight).

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