SF Fed Note: Unemployment Slightly Below Natural Rate

--Implies Elimination of Labor Market Slack, Economists Find

--Estimates Longer-Run Unempl Rate In Narrow 4.5%-5.5% Range Over Past Century

By Jean Yung

     WASHINGTON (MNI) - The U.S. unemployment rate has dipped below its

longer-run rate and indicates the economy is at full employment, according to a

new estimate of the so-called natural rate of unemployment from two Federal

Reserve economists. 

     That rate, which is unobservable but key to monetary policymaking, likely

hovered in a narrow range between 4.5% and 5.5% for the past century, Regis

Barnichon of the San Francisco Fed and and Christian Matthes of the Richmond Fed

said in the latest edition of the San Francisco Fed's Economic Letter published

Monday.  

     "The most interesting aspect of our estimated u-star is its remarkable

stability over time," they wrote. 

     "Recent readings on the unemployment rate have been running slightly below

our estimated natural rate, implying the elimination of labor market slack." 

     The unemployment rate fell a tenth to hit a 16-year low of 4.3% in July,

below the Federal Open Market Committee's most recent estimate of its longer-run

rate, 4.6%. With the economy creating an average of 180,000 jobs a month for the

past year, the FOMC also projects the unemployment rate to fall further to 4.2%

in 2018 and 2019. 

     Fed Chair Janet Yellen acknowledged in June after raising the Fed's policy

rate by 0.25% that the labor market was tight. "With inflation below 2%, I think

it's appropriate that the labor market be that tight," she said. At the same

time, to avoid the risk of overheating the economy, it's "also a prudent move,

to move in a gradual way to remove accommodation." 

     Barnichon and Matthes in their study used a new statistical approach to

remove "cyclical fluctuations" in the unemployment rate while allowing the

natural unemployment rate to vary over time.  

     "Such variation could be explained by changes in labor market regulation,

demographic factors, and other reasons unrelated to the business cycle," they

said. 

     Surprisingly, large historical movements in the unemployment rate did not

feed through to the natural rate "as much as one might expect," because

inflation also behaved as the Phillips Curve predicted, they said. 

     During the Great Depression, when unemployment spiked 22 percentage points,

inflation also fell rapidly; the natural rate rose just 1 percentage point, the

economists found. During World War II, when the unemployment rate fell to less

than 1%, the natural rate also moved little. 

     During the Great Recession, Barnichon and Matthes' model found a temporary

increase in the natural unemployment rate of about 0.4 percentage point, as

workers took advantage of extended unemployment benefits. 

     That result also matches closely with the Congressional Budget Office's

estimate, the economists said. 

     The full Economic Letter is available at:

http://www.frbsf.org/economic-research/publications/economic-letter/2017/august/

natural-rate-of-unemployment-over-past-100-years/

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

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