Hoover Daily Report

No Tapering Soon if the Fed Looks at Labor

via Wall Street Journal
Monday, September 30, 2013

The Federal Reserve's Sept. 18 decision to stay the course on its asset purchases surprised and confused many market participants, who felt the central bank had sent contradictory signals about its intentions. In fact, the Fed has behaved in a way completely consistent with Chairman Ben Bernanke's public comments, at least since July. A careful look at the labor market numbers suggests that if the Fed sticks to the chairman's words, there will be no significant tapering any time soon.

Before July, the Fed announced on a number of occasions that a 6.5% unemployment rate would indicate that it is time to start raising interest rates and winding down its easy-money policies. The unemployment rate has fallen significantly from its high of 10% in October 2009 to the mid-sevens. But the labor market is still sickly because, as I pointed out in these pages in June, the employment rate—the proportion of the working-age population that has jobs—has made little progress.

The employment rate is the best single indicator of labor-market health, and it is still hovering at around 58.5%, down significantly from its pre-recession levels of over 63%. The economy is adding jobs, but just barely staying ahead of population growth. Rather than making up for ground lost during the recession, the economy is still treading water.

Mr. Bernanke and other Fed governors are clearly aware of the distinction between the unemployment and employment rates. In his July 17 congressional testimony, Mr. Bernanke said that "if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment (my emphasis), the [Federal Open Market] Committee would be unlikely to view a decline in unemployment to 6.5% as a sufficient reason to raise its target for the federal funds rate." The jobs report for August showed the decline in labor-force participation and employment rates that the Fed feared.

On Sept. 18—following the FOMC's vote to continue its current pace of bond-buying—Mr. Bernanke reinforced the message. "The unemployment rate is not necessarily a great measure in all circumstances of the state of the labor market overall," he said. "We are looking for overall improvement in the labor market."

There are some positive signs. Monthly hires have picked up a bit and are now at 4.4 million rather than the 4.2 million that characterized most of the post-recession period. According to the Job Openings and Labor Turnover Survey, quits now exceed layoffs by the largest margin since the recession ended. Layoffs exceeded quits by 834,000 in April 2009; the most recent data, for July 2013, show quits exceeding layoffs by 755,000. Workers tend to quit more in healthy labor markets when jobs are readily available.

Average weekly hours have risen to 34.5 from the low 33s of spring 2009, suggesting some increase in labor demand. Finally, the four-week average of initial unemployment claims is at 308,000, only slightly higher than what would be expected in a normal economy. But at best these numbers suggest a better future labor market, not that current labor conditions are strong.

Does this imply that the Fed should continue its asset buying? Not exactly. While it is possible to claim that the situation would be worse if not for the latest round of quantitative easing, the labor market's behavior since September 2012 does not provide strong evidence that the bond buying has done much for economic growth.

Nevertheless, the Federal Reserve's recent statement that it will maintain its asset purchases is consistent with its desire to see a substantial improvement in the weak labor market. The decision also may reflect a fear of repeating the prolonged contractions of the 1930s, much of which is attributed to contractionary Fed policy.

All of this implies that if the Federal Reserve is true to its word, there likely will be no significant policy change in the near future. The employment rate simply cannot recover very quickly. But if the Fed concludes, as have many economists and analysts, that quantitative easing has run out of steam, it can point to other labor market indicators that provide a face-saving way to get back on a more historically consistent path.

Mr. Lazear, who was chairman of the president's Council of Economic Advisers from 2006-09, is a Hoover Institution fellow and a professor at Stanford University's Graduate School of Business.