The seven-percent solution to U.S. unemployment

October 20, 2011

As policymakers debate how to bring down an unemployment rate stubbornly stuck above 9 percent, Chicago Federal Reserve Bank President Charles Evans and Boston Fed President Eric Rosengren are embracing what might be called “the seven-percent solution.”

It works like this: the Fed pledges to keep rates near zero for as long as it takes to get some real improvement in the labor market – an unemployment  rate, say, of 7 percent – as long as inflation doesn’t get out of hand. That way, every time some good economic news comes out, markets don’t immediately start pricing in a rate hike, undoing the very easy policy that the Fed sees as necessary to pull the moribund jobs market from its deep hole. Don’t you worry about a little bit of inflation here or there, the Fed could say –  it’s steady as she goes until unemployment dips below 7 percent.

What, though, is so special about 7 percent? Certainly, it’s much better than the current 9.1 percent. But it still would leave millions unemployed, and Evans himself has said he believes that unemployment normally runs at less than 6 percent. Why settle for a bigger number?

A bit of sleuthing into recent Chicago Fed research suggests one possible answer. In a paper published as part of its “Economic Perspectives” publication, Chicago Fed senior economist Gadi Barlevy takes a deep dive into the data on job vacancy rates, which rose sharply in the early part of the recovery even though unemployment was also climbing. Some researchers say this trend suggests that firms want to hire but simply cannot find the right kind of workers – a structural fault in the economy that easy monetary policy cannot possibly cure.

Drawing on the work of Nobel Prize winners Dale Mortensen and Christopher Pissardes, Barlevy argues that only half, if that, of the increase in unemployment from the Great Recession can be attributed to mismatches between employers’ needs and employees’ skills.  The rest, he says, “must be because firms find hiring less profitable.” He goes on:

While there is little monetary policy can do if firms find it more difficult to find suitable workers, there may be scope for monetary policy when firms find it less profitable to hire workers than during normal times….if jobs are less valuable because of insufficient aggregate demand on account of some market friction, there may be a role for monetary policy to stimulate demand.

Still, Barlevy says his research shows that part of the increase in unemployment does indeed come from a labor market shock that monetary policy cannot offset: “This type of shock by itself would lead to an unemployment rate of 7.1 percent.”

Which is one way of saying that the 7 percent threshold Evans and Rosengren want to use as a policy trigger could actually be the new normal for unemployment. If it is, letting the jobless rate fall any lower could set alight the fires of inflation.

Put that in your pipe and smoke it.

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Corporations have shipped all of the jobs overseas. They are not coming back. Get over it.

Posted by minipaws | Report as abusive