U.S. labor force dropouts want back in
April 21 (Reuters) – An army of U.S. labor force dropouts
stands ready to get back in the game when conditions improve,
implying wages, prices and interest rates will stay lower for
Rather than being the result of demographics or choice, the
rise in the number of people who are not actively looking for
work is in substantial part the result of low demand for labor,
according to a new study by David Blanchflower and Adam Posen,
both of whom are former members of the Bank of England’s
rate-setting Monetary Policy Committee.
“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,” Blanchflower, of Dartmouth College, and Posen, of
the Peterson Institute for International Economics write. ( here
That’s demonstrated by the fact that a falling labor force
participation rate has a statistically meaningful suppressing
effect on wages, they argue. The data shows this effect is
persistent over recent decades and increases, unsurprisingly,
during and after the last recession.
Modest gains in employment, therefore, will bring
moth-balled would-be workers back, which in turn will keep a
firm lid on wage growth.
That means the Federal Reserve will likely keep interest
rates low for longer than many anticipate.
That should be good for bonds, and the factors behind that
might partly explain why bonds have done as well as they have
despite the fact that the Fed is buying fewer of them.
And while one might argue that an ample supply of workers,
depressed wage growth, and low interest rates will be a sweet
combination for equities, much depends on your view of how
effectively the Fed will react to continued low wage growth.
All of this matters a great deal because if you believe that
the fall in labor force participation is due to baby boomers
deciding to spend more time with their grandkids, then using
monetary policy to try and counter that will only fan wage
If, as the paper implies, falling participation is in part
unemployment by another name, a central bank has both more
leeway to use monetary policy to stimulate employment and wage
growth and more reason to do so.
SIMPLE FORWARD GUIDANCE
Of course, this debate is already raging. Fed chair Janet
Yellen, noting the fall in participation to levels last seen in
1978, when far fewer woman were working, has said her view is
that “a significant amount of the decline in participation
during the recovery is due to slack, another sign that help from
the Fed can still be effective.”
That view is not universally held among Fed officials, but
broadly all of them agree that the unemployment rate, which has
dropped sharply, is by itself not a fantastic indicator of the
state of the labor market.
As a result the Fed has moved to a far more complex data set
to use to help set forward guidance of when it might eventually
raise interest rates.
Not only will it look at the unemployment rate, but also the
change in the participation rate, job turnover, wage growth and
long-term unemployment, among others.
That approach has advantages over simply setting an
unemployment rate as a threshold, but like reading tea leaves
makes almost any conclusion possible, both within the Fed and by
those trying to second-guess it. That could make the Fed less
effective, and most certainly will make financial markets more
volatile, all else being equal.
Posen and Blanchflower propose that wage inflation should be
used as the primary target of the employment side of the Fed’s
mandate. This has a lot to recommend it. Many of the other
factors the Fed will already be watching, such as participation
rate, under-employment and the unemployment rate, will influence
wage growth, and in ways which smooth out any structural or
demographic changes, or at least will until a more normal
For investors, the key question is will the Fed act on this
Yellen, based on her recent remarks and history, seems on
board, if not with adopting wage inflation as a target, then
certainly with regarding the army of labor force exiles as more
than a lost cause.
There is considerably less agreement elsewhere in the Fed,
and that brings up the very real possibility of a premature
interest rate rise, as conditions in parts of the labor market
improve and policy makers bet that wage growth will follow.
Perhaps even more likely is premature jawboning by Fed officials
about upcoming rate rises which, along with anticipated
inflation, never quite arrives.
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at email@example.com and find more columns at blogs.reuters.com/james-saft)