MNI EXCLUSIVE:Little Slack,But Don't Expect Wage Jump-Fed Econ

--Richmond Fed's Non-Employment Index Falls to 7.9% in July

--Broad Measure of Labor Slack Reflects Full-Employment Economy

--Low Unemployment Might Not Mean Wage Pressures, Hornstein Tells MNI

By Jean Yung

     WASHINGTON (MNI) - A broad measure of labor slack from the Federal Reserve

Bank of Richmond shows that resource underutilization is nearing its

pre-recession low, but even that may not mean the swift return of wage

inflation, a senior economist at the bank told MNI in an exclusive interview.

     That would suggest the Fed is further away from realizing its inflation

objective than many policymakers currently expect, since they have repeatedly

said they expect a tight labor market to generate upward pressure on inflation. 

     "People argue wages are not increasing that much and that says something

about the labor market that it's not tight. But even if you look at the period

before the Great Recession, there is not that strong of a relationship between

real wages and the unemployment rate," said Andreas Hornstein, one of the

architects behind the bank's Non-Employment Index.

     As the economy nears full employment, "There is an expectation that in the

end wage growth will pick up," he said. But the economic literature shows "there

is an absence of a strong correlation between real wage growth and

unemployment." 

     Hornstein collaborated with Marianna Kudlyak, a former colleague now at the

San Francisco Fed, and McGill University economist Fabian Lange to develop the

Non-Employment Index in 2014 to address a key problem in U.S. labor statistics:

How to measure the millions of people who are neither working nor actively

looking for jobs but who may still be available for hire.

     Following the Great Recession, large numbers of people dropped out of the

workforce and disappeared from the official unemployment rate. As the labor

market strengthened in recent years, that hidden manpower has come off the

sidelines. In June, more than 4.7 million people from outside the labor force

found employment, a record high. That was more than double the rate of

unemployed people who landed jobs that month and underscores the relevance of

the out-of-labor-force group to today's full employment debate. 

     While the standard unemployment rate, the so-called U-3 rate, only tallies

individuals who looked for work in the previous four weeks, the Non-Employment

Index takes a much broader view of the labor resources available to employers.

     The index, which is regularly cited by Fed policymakers as an alternative

metric of labor market health, incorporates every type of available labor in the

working-age population by weighting nine different groups according to their

attachment to the labor force. 

     In July, the index dipped a tenth to 7.9%, matching a low last seen in

March 2007 just before the Great Recession. It now stands a mere 30 basis points

above the series' all-time low of 7.6%, recorded near the peak of the dot-com

boom in January 2000. The index is available on a monthly basis going back to

1994.

     The Labor Department's headline unemployment rate fell to 4.3% in July, a

16-year low. It also sits at about 30 basis points above the average

unemployment rate for the year 2000, the last time the United States was at full

employment.  

     "U-3 is about as low as it has ever gotten. For the Non-Employment Index,

over the long run it tends to move with the unemployment rate. So potentially it

could go lower, but it would be relatively unusual compared to what we've seen

over the last 25 years," Hornstein said. 

     In other words, the Non-Employment Index is telling the same story as the

Labor Department's unemployment rate: We are in a very tight labor market. 

     Hornstein also found that his index moved more or less in lockstep with the

standard unemployment rate before the financial crisis and then again after

2014. In the 2007 to 2014 period, his research suggests the Labor Department's

rate overstated how much the labor market deteriorated, distorted by ballooning

numbers of long-term unemployed displaced by the crisis. That group, the

economists found, were only half as likely as the short-term unemployed to get

hired.

     With the U.S. economy once again in the vicinity of full employment, debate

rages at the Fed: How low can the unemployment rate go without setting off

inflationary wage pressures? 

     Hornstein said there is some evidence that the current average wage growth

rate understates true wage growth due to the changing composition of the

workforce. More people are coming into the labor market at the low end of the

wage scale now than before. 

     But he believes the ultimate answer may have less to do with the

unemployment rate than worker productivity. 

     "Over the long run, if you look at the U.S. economy, real wage growth is

associated with labor productivity growth," Hornstein said.  

     Since the crisis, productivity growth has languished, he said. "If this

relationship between real wage growth and productivity continues to hold, you

should not expect a lot of real wage growth. Given we have low inflation you

shouldn't expect a lot of nominal wage growth." 

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

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