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--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
[TOPICS: M$U$$$]