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How Close Are We to Full Employment?

Maybe we're not very close, says Janet Yellen. Here's Greg Ip:

Economics Blog : Fed May Be Questioning Labor-Market Tightness: The Federal Reserve still sees the labor market as tight, but may be less sure of that than it was six months ago. The continued low level of the unemployment rate is one of the reasons the Fed has continued to say in its policy statements that the “high level of resource utilization” could add pressure to inflation. For some time Fed officials have thought slower economic growth would push up the unemployment rate, creating slack in the economy that would help keep wage and price gains from accelerating.

But there are signs the labor market isn’t as tight as the low unemployment rate suggests. One reason is the absence of a notable acceleration in wage growth. Average hourly earnings rose 0.3% in June from May and were up 3.9% from a year earlier, in line with the rate of growth for the past year. The more comprehensive employment cost index grew 3.5% from the previous year in the first quarter, in the range of the past several years. Broader measures of compensation accelerated in the first quarter, but that may reflect the vagaries of employee stock options and one-time bonuses.

Federal Reserve Bank of San Francisco President Janet Yellen, in a speech delivered via video conference to the Risk Management Institute of Singapore early Friday local time, said, it’s possible “labor markets may not actually be particularly tight,” citing the restrained growth in employment costs. The Conference Board’s index of job market perceptions, she said, suggests that labor markets are “only very slightly on the tight side.” Ms. Yellen suggested she was sympathetic to these “benign explanations.”

The low unemployment rate reflects in part a recent drop in the “participation rate” — the share of working-age people either on the job or looking for work — from 66.4% in December to 66% in May. It edged back to 66.1% in June. Much of the drop in the participation rate has been among teenagers; contrary to the Fed’s expectation, the participation rate of older workers has actually risen. Jared Bernstein, senior economist at the Economic Policy Institute, a Washington think tank, noted the participation rate has fallen especially sharply for young people, blacks and Hispanics, groups who are “especially sensitive to the economy’s ups and downs.” If those missing workers were reported as unemployed, the jobless rate would be 5% instead of 4.5%, he said in a report.

Peter Hooper, chief economist at Deutsche Bank Securities, said, “The prevailing view at the Fed seems to be that the labor market is tight, but with some uncertainty because the tightness has not yet shown up in a clear upward trend in labor cost inflation and because labor force participation has jumped around a good deal.”

This suggests that while the Fed still expects a rise in unemployment, such an increase may not be essential to its expectation of moderating inflation. Still it has other reasons to remain on the alert, such as the possibility that its recent decline has been led by temporary factors that could fade in coming months, and the possibility that higher import and commodity prices could feed through to other goods and services.