Williams Discusses Jobless Rate & Monetary Policy

In a speech today titled, “The Economic Outlook, Unemployment, and Monetary Policy,” FRB-SF President John Williams spent a fair amount of time discussing factors influencing the unemployment rate. Before doing so, he claimed that the Fed’s policies “have given a shot in the arm to the economy by significantly reducing longer-term interest rates.” He acknowledged that they’ve been rising lately, but said that they are “still quite low.” He then reminded his audience that monetary policy is now closely tied to the unemployment rate. If it continues to fall toward 7% by the middle of next year, then QE will be phased out and terminated by then. If it continues to fall to 6.5%, that will be the threshold for the FOMC to start discussing raising short-term rates. He observed: “Clearly, the unemployment rate plays an important role in our thinking and communication about future policy. Therefore, an important issue is whether it is giving an accurate read on where things stand relative to our maximum employment mandate.” He then went on to address this important issue as follows:

(1) Overall, he believes it is a useful measure that “closely tracks other indicators of how much slack there is in the labor market, such as data from surveys on the share of households that finds jobs hard to get and the share of businesses that say it’s hard to fill openings. This adds to our confidence in its reliability.”

(2) He is not a fan of the employment-to-population ratio, which has been much more downbeat about the labor market than the jobless rate: “Although the unemployment rate is by no means a perfect measure of labor market conditions, the employment-to-population ratio blurs structural and cyclical influences. That makes it a problematic gauge of the state of the labor market for monetary policy purposes.”

(3) He also discussed structural reasons behind why the labor force participation rate has been falling and may also exaggerate the weakness of the labor market: “The overall ranks of the unemployed have been declining because many people are leaving the labor force, rather than finding jobs. But, it’s important to remember that much of this decline in labor force participation reflects long-running demographic trends, such as retiring baby boomers leaving the workforce. In addition, in recent years there has been a big exodus of young people and so-called prime-age adults. Again, some of this is related to ongoing trends, such as an increasing share of young adults enrolling in school, and workers moving onto disability rolls.”

He summed it all up as follows:

All this gets quite complex. On the one hand, we have structural trends, like the aging of the workforce and young people spending more time in school. On the other hand, we have the effects of a weak economy, which discourages people from looking for work. From the standpoint of gauging the state of the labor market for monetary policy, it is crucial that we distinguish between structural developments in the labor market and the effects of a weak economy. Recent estimates by the U.S. Bureau of Labor Statistics and others suggest that structural factors account for most of the decline in participation over the past several years.8 According to this research, structural factors reducing labor supply are the main reason that the employment-to-population ratio has stayed so low while unemployment has declined. Therefore, the employment-to-population ratio is sending a much too pessimistic signal regarding the amount of slack in the labor market. On the other hand, this evidence also suggests that the unemployment rate probably is overstating somewhat the extent of improvement in the labor market. However, over time, as discouraged workers rejoin the labor force, this problem should go away.