MNI EXCLUSIVE: Fed On Watch For Long-Term Labor Market Damage

By Jean Yung and Pedro da Costa

     WASHINGTON (MNI) - Top Federal Reserve policymakers seeking new ways to

measure a historic economic slump are trying to gauge the degree of permanent

damage to the labor market wrought by Covid-19 as they prepare to refine forward

guidance and asset purchases in coming meetings.

     The "neutral" interest rate has likely fallen, while the "natural" rate of

unemployment may have risen, San Francisco Fed research director Sylvain Leduc

told MNI. The task of determining the extent of the changes, he added, has been

complicated not only by elevated uncertainty, but also by the need to supplement

traditional data sets which have failed to keep pace with reality as joblessness

surges to Depression-era levels.

     In addition, estimating the new levels of "R-star" and "U-star" will depend

on alternate scenarios for the rebound, based on whether social distancing

measures are reintroduced, more fiscal stimulus is passed and the pace of the

global recovery. Officials are likely to emphasize at the June policy meeting

that these scenarios may be equally likely in the highly uncertain environment.

     "Our assessment of the impact on the long term would be useful for the

public in general to know," Leduc said, noting that estimates of R-star and

U-star helped guide markets following the Great Recession.

     As of December, the last time the Fed issued official economic projections

before skipping them due to heightened uncertainty in March, officials projected

the "neutral" rate of interest to be 2.5%, and the long-run jobless rate at

4.1%. Estimates of the long-run jobless rate had been as high as 6.3% after the

financial crisis.

     --BENCHMARKS IN FLUX

     After an era of falling U-star and R-star, which allowed the Fed to run the

economy hot to soak up lower skilled workers, the pandemic has upended the Fed's

frame of reference.

     A prolonged recovery may mean longer periods of unemployment for some,

potentially creating a bigger permanent degree of slack. In estimating U-star,

"so much depends on the evolution of the virus and how much scarring there could

be on the economy," said Leduc. "I could think about more dispersion for that

variable."

     Meanwhile, a lower R-star means the Fed can push even further with

stimulus. "I wouldn't be surprised if there's downward pressure on estimates of

the neutral rate," Leduc said, as a response to high uncertainty and the severe

shock to demand.

     At the April meeting, Fed officials said they could adopt "outcome-based

forward guidance" tied to certain levels of the unemployment rate or inflation

before they would consider raising rates again.

     --ALTERNATIVE GAUGES

     Facing a cloud of uncertainty, Fed staff are turning to alternative

measures of economic activity and labor market engagement and relying on more

frequent outreach with businesses to gather data.

     Leduc is now following a Daily News Sentiment Index measuring consumer

confidence based on the tenor of media coverage.

     Similarly, the Dallas Fed has developed a Social Distancing Index using

geolocation data from a large sample of mobile devices to gauge the level of

economic activity. Several other banks now run a weekly economic index. They

show that while activity and confidence have rebounded, the economy remains far

from where it was in early March.

     In addition to the official unemployment rate, Richmond Fed research

director Kartik Athreya told MNI he's paying attention to the

employment-population ratio, labor force participation and regional surveys of

manufacturers and service firms.

     "We are now also using a battery of other near-real-time micro data on

consumer spending and work hours, and are making extremely heavy use of our

regional executive and community development team outreach to understand

real-time conditions," he said.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]